Description
401ks are the top retirement account out there. Millennials every day make contributions to a plan they barely understand. In this episode of Millennial Money Matters, we delve into the mysterious world of 401k plans. We discuss the three main decisions you make with 401k plans, how target date fund works, 401k rules and many more. If you have many questions about 401k plans, this episode is for you.
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Transcription
Here we are for another episode of Millennial Money Matters with Derek and Kelly. Kelly, how you doing?
I'm doing great. I'm doing great. How was your weekend?
I am still recovering. I was, my wife was on a girl's trip for four days and this is day four and I am glad she's coming back today.
And so you've been alone with two kids for four days?
Yep, they are five and three, two boys, so they have endless energy. We did probably, I think, Six different activities, like going out of the house, going to different houses, going to the science museum, going to birthday parties. T-ball pictures, which was a cluster.
Oh, I was also at T-ball pictures. I saw you also. And that was chaos.
Yeah. There's just bats everywhere. Yes. Kids everywhere.
Small five-year-old swinging bats indoors. Yeah,
what could go wrong?
Yeah, we were there for double duty because we have two kids in baseball. So my husband was... at Baseball Pictures from 10 a.m. until almost noon.
Well, he's a coach, so he's obviously very important.
Yeah, very, very important. Yeah, no, that was an adventure. But yeah, four days with your kids, no matter what. That's a lot of days alone.
You know, I get a lot of credit for single parents out there because I think when you're kind of in that realm of used to doing this, you kind of have a rhythm. We don't have that rhythm yet. So if kids want to stay out late, they're like, Dad, can we do a little fort over the bed? I'm like, I don't know how we're going to possibly do this. You know, they want to sleep in the same bed and they don't. Yeah, it's fun.
Well, and then you also had the surprise rain on Saturday. Saturday was supposed to be beautiful. And then it rained from the moment we woke up until the moment we went to bed.
Kids and rain is always the best combination.
We were supposed to have two baseball games that day. Both got canceled. Both got canceled at the last minute. And we were like, now what?
Yeah, I know.
What are we supposed to do with you? We had plans. They're over now.
I tell you, we bought a bounce house for Christmas a couple years ago. And it's small enough to fit in our basement. It's been the best decision ever. Because with these winters in New England, you're just like, get in the basement. Get some energy.
Go jump in the bounce. Yeah. That's a good call. We have an inflatable water slide. So that's our summer activity, which also 10 out of 10 stars would recommend. Okay.
All right. See, you come for money tips, but here you get parenting tips. Correct.
Because this is Millennial Money Matters and lots of us millennials are dealing with children.
We are. Yeah. So what's our topic today, Kel?
Our topic today is 401ks. And I love this. Part of Derek and I's exploration of doing these podcasts are we have discussions about these topics. And 401ks are... I feel like a bit of a mystery to a lot of us in that our parents are not always the most helpful in educating us on 401ks because they come from the era of pensions.
They do. Yeah.
How's your pension? You're like, nobody's had a pension in 20 years.
Get a job with a pension. Where? Where? Government. That's about it.
But even the government, it's not super common these days.
They're getting worse. I have some clients in the other age of this pension program that work for the state of Connecticut here. And the ones that are about to retire are looking pretty. The younger folks, it's going to be a little dicey.
I see. So 401k is definitely more common. I think that there's a lot of myth around it. And even I, like as Derek and I chatted about this and I had questions and he's like, no, that's not true. No, that's not true. So I'm an educated financial professional and still don't necessarily know a lot about 401k. So tell me a little bit, Derek, like what's, give me some basic facts about a 401k.
First of all, your impression of me was spot on. I just want to point that out. Yeah, that was amazing. Well, you know, I always tell clients there's really three main things you need to worry about with a foreign K in general, and then I'll get to some crazy stats we have. But really when it comes to your decision on a foreign K, you want to think about how much you're saving, what type of tax treatment you're going to save, and what are you going to invest in? Let's not overcomplicate it. That's really the only things we're looking at. But in terms of foreign Ks in general, here's some kind of stats that I looked up. So basically about 56% of the workforce has access to a foreign K plan. So everyone thinks, oh, foreign Ks are ubiquitous or they're everywhere. That's actually not the case. It's kind of the same thing with the whole pension argument. not as many people had pensions as you thought. So a lot of us are actually on our own when it comes to retirement savings in general. So just keep that in mind. There's an average of 28 investment options in a 401k plan. So it's not like we've got a million options, like, no, you can't invest in Bitcoin in a 401k.
Oh, come on.
I want that. Never. Yeah. And then about the number one investment option is a target date fund. So we're going to get a little bit about what those are, why they're fit, about... 43% of plant assets are actually in a target date fund. If you look at Vanguard study, just on Vanguard assets, it's almost 60%. Yeah, so most people just default to that. So it's important to know how they work and what they're on. And we can talk about that a little bit. Do you want to know how much we have saved by generation?
I would love that because again, we're really targeted millennials here. But yeah, what are people saving?
All right. So here's the thing. We got some work to do. Okay. So Gen Z, they're just starting out. So let's give them a break. Their average Our 401k balance is $7,100 and their mean is $2,500.
But they got time.
They got a little bit in there, but they got some ways to go. Us millennials, we've got $44,900 on average and only $15,500 mean.
Which is not good because again, I'm an elder millennial. and I'm 41, which means my time to retirement is not that long.
No. I mean, this is the point where if you're not saving yet, you need to put in a ton more than you would if you just started earlier. So if you're listening to this thing, I'm a little behind, like get going. Gen X, we're at 145,500 average and then 44,000 mean.
So they're doing a little bit better. Yeah. Not enough to live on though. That's not 20 years worth of savings for you in your retirement. Not at all. That's like one year.
Right. And boomers, quite frankly, they're not doing much better. They're at 215 average and then 61,000 mean. So that is not a lot to live on when you're going to retire in three weeks.
They all thought they were getting pensions, so.
They did. And they probably don't have them. So. We'll see. So that's kind of the current state. So clearly we have some work to do. The 401k is one option to help build up your wealth for retirement. So Kelly, do you want to ask a couple of questions? I know you had some questions.
I'm depleting this in that I feel like when we talk retirement, people automatically default to the 401k. Like, yeah, yeah, I got a 401k. And again, good option. But can you get a 401k if your employer doesn't offer it? Like, is that something that everybody should have a 401k or it's really, are you just using it if it's available from your employer?
So a 401k is an employer-driven plan. So it's only available if A, your employer offers it, or B, you're a solo practitioner, solopreneur, whatever you want to call it. You can set up your own. It's called a solo 401k. Those are really the only avenues to actually go get your own 401k plan. So if you're just working for so-and-so X, Y, Z company, and they don't have a plan, you cannot get a 401k. Okay.
Now what is... So I have a 401k. I'm putting money in it. Now... I think the biggest benefit that most of us know is your employer can put money in it as well. What drives that? What drives how much is put into these? How does that work with your employer?
So the employer typically will decide what you're referring to the match. And typically, there's two money types that go in there. I'm going to go into four. There's four money types. There's the money that you put in, that's considered the employee contribution. Then if an employer offers a match, not all of them do. They'll match either like dollar for dollar to X percentage or 50% to X percentage. Usually it's some cap amount. Then there's the profit sharing. So usually if it's a smaller business and the owner has a really good year, incentivizes the folks, say, all right, I'm going to dump some extra money in the plan. They'll do that for you. And then some plans, and this is where every plan is a little unique, so you have to read it and talk to a nerd like me that will actually read these documents and understand them. They offer what's called after tax. So that's above and beyond what you put in as an employee. you can actually put in after-tax money. So if you look at all four of those together, you can put it up to, in 2024, $69,000 a year into a 401k plan.
Oh, so you can't put whatever you want in there?
No, there's limits. So the employee part is $23,000.
Oh, I can only put $23,000. So if I want to save more than $23,000, then I have to have more than a 401k? Correct.
Or you have to be over $50,000, because then you get the catch-up, which is another $7,500 for this year. Or if they have, like I said, the after-tax option, you can get it up to 69 if you're doing that. But not a lot of plans out for the after-tax. It's pretty rare.
Now, what happens, I think for a lot of us, right, our parents'generations often started a job in their 20s and worked there for the rest of their career, right? So 40 years. That is not the same for millennials. We're kind of job hoppers. It's a hallmark of the millennial generation that we have hopped jobs. And you may have a collection of 401ks. So I, for example. if I was to count, most of them have been rolled over at this point, but I have had six different 401k plans, six different employers. Should we be leaving those at our former employer? Should we be rolling them over? Like, what do you do with these things? Because I think a lot of us just, it's living somewhere. It looks like it's making money. So we're like, not going to worry about that. But like, should I be rolling that in? Do I roll it into a new 401k? What do I do with that?
Well, so I'll just break down the, you basically have a few options when it comes to that. So option one is you can leave it in the. former employer's plan. Some of the downsides of that is like, let's say they go out of business or they move plans or the people you don't know don't work there anymore. They can be a lot harder to track. I don't love it leaving them there, but you can do that as an option. The other option is you could roll it into your new company's 401k plan. Almost every 401k plan is going to let you roll money into it. The other option that I hate is you could just take all the money out, but then you're paying taxes and a 10% penalty. So not necessarily the best choice. And then the fourth one is rolling the money into an individual retirement account. So you have Roth dollars, roll into Roth IRA. If you have traditional, roll into traditional IRA. There's some pros and cons to each. Like I mentioned, there's 28 investment options on average in a 401k plan. It's okay, but IRAs literally have endless amounts. So there's thousands of investment options.
Can I invest in Bitcoin?
Not in a 401k plan, but you probably could in an IRA. So it depends. Do you want more control over what you have? um the other kind of random thing that i'll bring up to people and usually no one says anything about it but it's creditor protected in a 401k plan it's not in an ira um and i did have a client where that actually did make some sense because he had a pharmacy and he's like you know in case anything ever happens with that um that's
one thing to look at is 401k assets are creditor protected creditor protected all right so what if i'm looking at 401k options you know i i have a 401k right now i my money comes out it goes into it I didn't really, I had to pick aggressive. slightly aggressive or less aggressive as my investment options. So it wasn't a lot of choices that I was getting. Should you have your, if you have an employer sponsored plan, should you have your financial advisor take a look at that documentation and help you choose even if they're not the one managing that plan?
Well, technically we're actually not really supposed to help them pick the options in the plan because we're not directly managing those. But I think it is worth coordinating the investment options with what you have outside of it in general.
So just have a conversation so everybody's on the same page. Now in the employer portion, now I think a lot of us, right, when we look at the balance of our 401k, like I open it up, I see monies, I'm like, look at all those monies, but they're not all mine.
No, you'll probably see two, three line items depending on how much tax you have. So you have your employee contribution. That's the money you put in. That money is always going to be 100% yours. So if you left three weeks after joining the employer, that money's always going to be yours. The other option is the employer match. And those typically will have a vesting schedule. Some of them don't. I'm not going to get too technical with it. But that's one thing you want to make sure you understand in your plan because some will have a three, four, five, up to a six-year vesting schedule. So it means you have to be at the employer for six years. And some are cliffs where, you know, maybe first two years you get nothing. And then all of a sudden you get 50% of it. And some will get 25% each year. So you just really want to make sure you understand when the employer gives you money, when is that officially yours.
And when can you take money out of a 401k?
While you're in the plan, there's not a ton of options. And this is, once again, going to be plan specific. But the general options you have are taking out as a loan, which we can get into. And then generally, some plans have hardship withdrawals. So there's a death, a disability, death of a family member, something like that, where you need to take some money out penalty free. They'll let you do that. Otherwise, if you just withdraw money, you're paying taxes and a 10% penalty.
Now, what age can you? get the money out of that on a regular basis without all these penalties.
Age 59 and a half is when you can officially get all that with all the penalty issues.
Half seems like a common age in the conversations we've had for retirement, right? 59 and a half is like, that's like the, I'm now a real grownup.
Yeah. I don't know how they pick that specific age considering everything else is 65 or social security even starts at 62. So I'm not sure exactly how they came up with a 59 and a half, but that's generally where, okay, now I can move money out. And a lot of times you could actually move money out while you're still working there. So if you have like my big kind of pet peeve with 401k plans, they generally have very mediocre options when it comes to actually taking income in retirement. Generally, there's like three bond funds and a stable value fund, which is basically a money market, which pays half as much interest as you would get like a high yield savings account. So you can actually take money out and do what's called an in-service distribution and get money to another IRA while you're still working. Because generally, you can't just roll over your 401k while you're still working to an IRA.
So let's talk about loans. A lot of us will see, especially we've covered in other episodes, that a lot of millennials don't have a lot of savings. We don't have a lot of emergency funds. So say I'm a millennial, but I have done well with my 401k. I've got $200,000 in there, but that's kind of my money. That's what I've got. And I want to buy a house, right? Here's your friendly neighborhood mortgage lady. And I want to borrow money from my 401k. Can I do that?
You can. So you can take a loan out for any reason. They're not going to ask you, like, what are you taking this money out for? But with a loan, there's definitely some things you want to watch out for. like once again, the plan documents will dictate like what you can take out, how much, but generally it's about 50% of what you have in there. So if you have 200,000, you can take a loan up for about a hundred thousand. Uh, everyone says, well, great. I'm paying myself interest, but you are taking money out of an account that is earning money hopefully, or is at least invested. Um, so that's, there's an opportunity cost associated with that. Uh, and the one thing I mentioned to you was, um, if you leave your employer, you're going to owe that money back right away. Oh, so if you take out a hundred thousand dollars and you say, yeah. I got my new house. I'm going to get a new job, my whole new life. Guess what? You got to pay that $100,000 back right away.
Now, what happens if you leave that 401k? Can you move the 401k while you have a loan on it?
Nope. No, you need to close out all debts before you can move that 401k.
This is good to know. Yeah. And I do have clients on the mortgage side that will take out 401k loans for things like down payments and stuff like that. And a lot of times they'll try to ask us, the lender, a lot of questions about it. And I always defer right back to you need to speak to the plan administrator. Because every 401k is a little bit different and the rules are a little bit different. And then that vested amount, a lot of times you can't borrow the employer contribution. And if you have an employer that's contributing a lot, a lot of what is in your plan may be an employer contribution and you can't necessarily touch those funds.
Yeah. Before you go the loan route, make sure you go through the plan document. Every plan is going to have a plan administrator. That may be someone in HR. That may be a financial advisor attached to it. That may be. They're called third-party administrators. There's going to be someone you could talk to that can outline the ramifications of the loan. And generally, there's a loan fee. It's not usually much. It's usually a couple hundred dollars. But just know that those are some of the issues you can run into with loans. Although I thought it was interesting what you were telling me about how loans are countered with mortgage with 401Ks. So I'd love to. Yeah.
People are looking for down payment money and they're trying to figure out ways to get down payment money, especially if you're selling, say you own two houses or you own one house, house A, and you're trying to buy house B before you sell house A. And that is a very common scenario right now is I want to buy a new house, but I don't want the seller of my new house to think that it's contingent upon the sale of my old house. So I need to borrow money for my down payment because I'm not necessarily going to close on my sale first. So people will turn to their 401k. So what's great about that on our end from the mortgage end is we don't count for a 401k loan as part of your debt to income, where if you were to take out any other type of loan that's somebody else's money, if you've got a $300 a month payment, that's $300 that's hit on your debt to income. And a lot of people will sometimes take out like home equity lines on their current home to use as a debt payment on their new home. Well, if it's a $300 a month payment, that's $300 that we're going to count. The reason why we don't use... that debt in a 401k loan is you are borrowing money from yourself. It's not another creditor. So if you were to theoretically not pay it back, you are just not paying yourself back. You are not, it's not another person whose money is owed to them.
Yeah. You're not defaulting on. Exactly. You know, they're not going to come after your house or other asset, right?
There's ramifications on the 401k, right? And there's ramifications. You're going to pay taxes. You're going to pay penalties. And honestly, I always tell people it costs a lot of money for to get that money if you don't do it correctly. but we don't count it in your debt to income because it's your own funds.
That's interesting. I never actually never heard of that. I mean, I'm in general just more conservative as a financial advisor. So I don't love the taking money out of loans, especially in that scenario where it's like really time because I know a lot of things can go wrong at closing. Yeah. Last minute, you never heard of like, oh, shoot, now I'm going to get the money back on day, you know, 90 or 98 or whatever. You're like, uh, what do I do about it?
Back into there right now.
Yeah. So that's, you know, I just generally. I generally, my thing is when you're thinking about how much do I put in the 401k, it should be for retirement. Like think this is my retirement money. And if you really need to save it for a house, I would still recommend, okay, let's, let's create an account for that. But I do understand, Hey, there's an opportunity where like, I have this house, I need a little extra money for it. It's going to really help my cashflow moving forward. You know, it can make some sense. I like that more than, Hey, I need to buy a car. I love this. You know, I don't know what you call Lexus or whatever you want to say. Like, I need to get this. I'm going to borrow my money for like, there's better assets to buy things with. The houses are one thing. Buying, taking loans out for things is probably not my favorite option.
Yeah. And I would agree with that too. I think for us on the lending side, it is a little bit of a last resort. Again, can be useful if you are on the younger side. I think it's less of a big deal. I have occasionally had people nearing retirement who are borrowing funds from their 401k. And that definitely gives me, you need that money making money at that point. You do. Yeah. You need that money making money. And as you said, there is a time cost in borrowing that money because you're taking it out of the market. You're taking it out of your investments. And like, what if there's a big upswing in the markets while the money's out, you didn't capitalize on that.
Right. Because the argument I always hear is, well, I'm paying my self-interest and the interest could be, I mean, I don't even know now, and that's probably 8% or 9% right now. So like, oh, cool. I'm earning 8.9%, but you're paying that. So it's not like it's free money. But if the money was in the market and the market goes up 20% that year, you lost 12%. Yeah,
exactly. So it's definitely something to contemplate. Now for these 401ks, you use the word vested and we... Didn't really get into that. What does vested mean? Like what is the definition of that? And why do I care if I'm vested or not other than me leaving my employer?
That's just essentially when the money becomes yours.
So it's not yours until that point.
Right. So the money you put in is always 100% vested. The money your employer puts in most of the time will have a schedule. Sometimes it doesn't, but that's where you need to understand how that works. Because some plans, they'll give you the money right away and it's yours day one.
Okay. So what if I take a loan out? Right. So I'm going to borrow money. I'm not fully vested. I am going to leave my employer. Now you said I owe that money back. Right. If I leave my employer. What are the penalties for this? Because that's the part like that I think people don't get is if you're paying, it's not just the 10 percent penalty. You're also paying taxes.
Yeah. It's going to they're going to basically treat it as you taking the money out.
It's gone. Right. Correct. And you're not going to get it back. Correct. So that could be that could be. big financial hit for people.
Especially depending on your tax bracket. So there's a whole lot of issues you really wanna be aware of, okay, like if X, Y, Z happens, you know, what do I do? So it's good, you know, go for the loan, that's fine. Just make sure, okay, if it hits the fan, what am I doing?
Now, employer contribution-wise, should you be maybe checking? that what that is before you accept jobs like is that something that should be a part of your contemplation if you're looking at job a and job b and one match is six percent and one i'm going to use nine which derek will laugh about i i work at used to work at an employer that matched nine percent um and it was like unheard of i know i'm gonna faint over here it's crazy nine percent it was nine percent and my fun fact is i did not contribute to that 401k for the first three years that i worked for this and you didn't have to put nine percent in to get the nine right put six six Cool. Yeah. It was a big money waster. It was a big money waster. But again, I think especially, and this is probably those Gen Zers, is when you're in your early 20s, first off, retirement seems a thousand years away, right? So for me, when I was in my 20s, I think they were taking like $50 out of my paycheck. But at that time, I was like 24, $50 in my pocket felt like so much more than $50 in my retirement. And if I had ever understood what that money meant to me today, I would have happily given them my $50. But I mean,
that meant $75 was going in for you on top of that.
On top of that. Yeah. And I just didn't understand that. And what's that money now 20 years later? Like lots of money.
Yeah. I think it's important to put a little perspective too, because a lot of people think a lot of, unfortunately, when you read the documents, it's always percentages. So it's like, oh, it's 6% of the salary, 3%. But if you're like, all right, let's be real here. If you make $50,000, 3% is $1,500 a year.
Which is not a lot.
It's not. Crazy. It's a little over a hundred dollars a month. So it's not like, oh my God, for sure, almost all of us can find a hundred dollars a month somewhere, even 50. Right. So the fact that they're going to double that money for you, now you have $300 going to your account every single month.
Yeah. What could you be doing with that in 20 years?
Right. And so it's, it's, um, you know, basically I think the stat is if you started at 25, you need like $581 or something along those lines to get a million by the time you're 65.
Well, and a million, I think we talked about this on an earlier episode, like. A million sounds like a lot. That's the minimum that most people need in retirement. Like a million will get you like continuing to live the lifestyle you've been living while you're employed and some of your health care costs covered. But you're not on a yacht at a million dollars in retirement like living the high life. Your life is OK. You're paying your bills. But you have to live on that, especially because people are living longer and longer with more health care costs. If you're retiring at 65 and you live to be 95.
Good luck.
A million dollars for that length of time does not go very far. No.
Well, you know, one point I want to make about the match, because I think it's the biggest missed opportunity I see, because folks that aren't taking advantage of it, it just drives me nuts, because you're automatically getting a 100% rate of return in most cases. You got a 150% rate of return. Yeah,
but it didn't do it.
On average, the stock market earns 10. So you're doing 10 times what the stock market does with no risk, because the employer is just throwing money at you. So now you're compounding that plus a 10% on top of that. It's such a missed opportunity. And it's like if I gave you $100 or you gave me $100 and I said, all right, here's $200 back. You do that all day.
All day long. I'd be like, sure, here you go.
Yeah, why not? The only difference is it goes into a different account that you can't touch for a little while, which I get is probably annoying. But it's such an opportunity to make an extra wealth.
Now, what if your employer doesn't match? Is it still worth it to have a 401k?
Generally, it is because it depends on your situation. But especially for higher income earners, it's... and your W-2, it's going to be one of the only tax vehicles you have. Because when you make too much money, you get phased out of a Roth. When you make too much money, you're going to have a tax problem, right? So the pre-tax piece of it's going to be really important for you. And if you're doing both, you can actually do a backdoor Roth with a pre-tax. So you can really probably get a little weeds here, but basically you can-Backdoor Roth. I don't know who names these things. Yeah. But basically you can leverage that as a tool. And a lot of people are like, oh, it's a scam. You see the stuff online now. It's like, don't do this. Do this instead. Invest in real estate. It's like, okay, let's take a break here. If you're not getting a match, it's still a good vehicle to use because you are getting that tax treatment. Just be frank. W-2 people do not have tax deductions. Good luck.
Yeah,
no. You don't open an LLC for a W-2 person. You can't just do all this stuff you hear on TikTok, right? So you do need that option to say, okay, I'm going to put some money in here. It's going to be my retirement account. This should not be, across the board, the only thing you save for retirement. because you are locking your money up. But it's a good tool to just kind of save automatically. I mean, for most of us, we're just terrible at saving in general. So having something that automatically comes out of our paycheck is really important too.
Yeah, right. Well, and that's it, right? It's the set it or forget it. It goes out. You don't even think about it. You're not moving it. That's what I like about the 401k is that it's like what I don't see, I don't know. It just comes out of my pay. Mine is a percentage that I put in. So it's base and I'm commission-based. So my... paychecks look very different every month, but it's a percentage. So some months it's a lot, some months it's not, but months that I get paid a lot, it's a lot of money. Cool. It's gone. I didn't even know that I got it. Right.
And you know, the other beauty of it too, is the market's going to fluctuate. So it's going to be up and down. So the nice thing is because you're putting money in every paycheck, which is every week, bi-weekly, whatever, you're going to write out, you know, you're going to kind of, I don't know. The gains aren't going to be as bad and the loss aren't going to be as bad either because you're buying things at a discount. You're buying things, you're buying less when the market's up. So it's going to even out your returns over time because you're being more consistent with it. Instead of being like, oh, yeah, I have an extra $50 after saving for three months. I'm going to dump a bunch of money in all at once and try and time the market that way. This is just boom, consistent, every single paycheck, money's going in the market and the market goes up. Great. If it goes down, even better because now I get things at a discount.
Yeah. And I'm one of those people where I'm not allowed to look at my 401k. because I get very wrapped up and like it went down and my husband's like, stop looking at it.
I wish I can get everyone to realize that. The best actual course of action for the market just suck until you're like five years before you retire and have a shoot up. That would be ideal because now you're buying things as cheap. Like you actually don't really want your, if you're younger, you don't want your balance to go up as much. You just want to put more money in it all the time because you're buying things at a discount.
Yeah. So it's getting a little better. So any last minute thoughts for people on a 401k, any tips, tricks, things they should know?
Actually one, one big thing I think we kind of didn't talk about it, which I mentioned earlier is a target date funds, right? Cause that's, that's the number one investment that most people have. And most people aren't really familiar with how they work. And I'll just give a quick primer on that because basically it's going to take your age when you think you're going to retire and it's going to be aggressive now. So more stocks over bonds. And as you get closer to retirement, it's going to be a little bit more conservative. One thing to watch out for, there are two types. And this is going to be a little technical here, but it's basically there's a through glide path and a to glide path.
That sounds a little Spanish.
You're like, what is happening?
What does that even mean? Derek right now.
And I'm going to explain it. So basically. A lot of people are like, oh, my target date sucks. I lost all this money in 2008. It's because they had a through glide path. They assume you're going to retire at 65, but your retirement's going to last 20 plus years. So we're going to stay aggressive. So people thought they were really conservative when they retire,
actually weren't.
And the two one says, okay, you're going to retire at 65. We're going to be conservative at retirement. So I think it's very important to understand which one you're in.
And now do you choose that when you set up your 401k?
So your employer chooses the, and each targeted company does it differently. Like Vanguard will do it differently than American funds or Fidelity. So you just really want to look at, you know, the easiest way to do it is kind of look at like a targeted, like 2020 or 2019 or 2015 fund to see where they are from an allocation standpoint. And it'll tell you if it's two or three. But it's a small thing that people probably don't think about, but if you're at 60 years old and you've got five years of retirement, like, do you really want to be that aggressive? Maybe you do. I don't know, but.
you know just something to watch out for because that's something that people don't realize they think they're conservative they're not oh i would have no idea so it's often very overlooked like i know it's a little nerdy but it's uh it's important to understand how that works and how you're saving well this is why having like a great financial advisor as a partner i think is so important because again even if they can't advise you on your particular plan someone to ask questions of so you understand what options you have and you understand like what am I signing myself up for? What do these words mean? Because I've never heard that before. And again, educated financial professional here, that was a whole different language to me. So I appreciate that.
Yeah. We have our own language over here. Yeah.
That's true. Well, listen, so do mortgage people. So it's part of the deal. And that's what we're here for, to educate people about all this stuff that nobody tells you about.
Yeah. So I mean, that's all I really have to talk about with the 401k plans. I think they're once again, the great tool, not the only thing I would ever invest in. But definitely a useful thing from a tax standpoint, from a savings standpoint. And get that free money because it's out there.
Get that free money from your employer, especially because you've earned it.
You have. Yep. It's part of the comp plan.
There you go. All right. Well, thanks for listening.
Yeah. Talk to you soon.
The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, Consult the appropriate qualified professional prior to making a decision. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies. Investing involves risks, including possible loss of principle.
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Description
401ks are the top retirement account out there. Millennials every day make contributions to a plan they barely understand. In this episode of Millennial Money Matters, we delve into the mysterious world of 401k plans. We discuss the three main decisions you make with 401k plans, how target date fund works, 401k rules and many more. If you have many questions about 401k plans, this episode is for you.
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Transcription
Here we are for another episode of Millennial Money Matters with Derek and Kelly. Kelly, how you doing?
I'm doing great. I'm doing great. How was your weekend?
I am still recovering. I was, my wife was on a girl's trip for four days and this is day four and I am glad she's coming back today.
And so you've been alone with two kids for four days?
Yep, they are five and three, two boys, so they have endless energy. We did probably, I think, Six different activities, like going out of the house, going to different houses, going to the science museum, going to birthday parties. T-ball pictures, which was a cluster.
Oh, I was also at T-ball pictures. I saw you also. And that was chaos.
Yeah. There's just bats everywhere. Yes. Kids everywhere.
Small five-year-old swinging bats indoors. Yeah,
what could go wrong?
Yeah, we were there for double duty because we have two kids in baseball. So my husband was... at Baseball Pictures from 10 a.m. until almost noon.
Well, he's a coach, so he's obviously very important.
Yeah, very, very important. Yeah, no, that was an adventure. But yeah, four days with your kids, no matter what. That's a lot of days alone.
You know, I get a lot of credit for single parents out there because I think when you're kind of in that realm of used to doing this, you kind of have a rhythm. We don't have that rhythm yet. So if kids want to stay out late, they're like, Dad, can we do a little fort over the bed? I'm like, I don't know how we're going to possibly do this. You know, they want to sleep in the same bed and they don't. Yeah, it's fun.
Well, and then you also had the surprise rain on Saturday. Saturday was supposed to be beautiful. And then it rained from the moment we woke up until the moment we went to bed.
Kids and rain is always the best combination.
We were supposed to have two baseball games that day. Both got canceled. Both got canceled at the last minute. And we were like, now what?
Yeah, I know.
What are we supposed to do with you? We had plans. They're over now.
I tell you, we bought a bounce house for Christmas a couple years ago. And it's small enough to fit in our basement. It's been the best decision ever. Because with these winters in New England, you're just like, get in the basement. Get some energy.
Go jump in the bounce. Yeah. That's a good call. We have an inflatable water slide. So that's our summer activity, which also 10 out of 10 stars would recommend. Okay.
All right. See, you come for money tips, but here you get parenting tips. Correct.
Because this is Millennial Money Matters and lots of us millennials are dealing with children.
We are. Yeah. So what's our topic today, Kel?
Our topic today is 401ks. And I love this. Part of Derek and I's exploration of doing these podcasts are we have discussions about these topics. And 401ks are... I feel like a bit of a mystery to a lot of us in that our parents are not always the most helpful in educating us on 401ks because they come from the era of pensions.
They do. Yeah.
How's your pension? You're like, nobody's had a pension in 20 years.
Get a job with a pension. Where? Where? Government. That's about it.
But even the government, it's not super common these days.
They're getting worse. I have some clients in the other age of this pension program that work for the state of Connecticut here. And the ones that are about to retire are looking pretty. The younger folks, it's going to be a little dicey.
I see. So 401k is definitely more common. I think that there's a lot of myth around it. And even I, like as Derek and I chatted about this and I had questions and he's like, no, that's not true. No, that's not true. So I'm an educated financial professional and still don't necessarily know a lot about 401k. So tell me a little bit, Derek, like what's, give me some basic facts about a 401k.
First of all, your impression of me was spot on. I just want to point that out. Yeah, that was amazing. Well, you know, I always tell clients there's really three main things you need to worry about with a foreign K in general, and then I'll get to some crazy stats we have. But really when it comes to your decision on a foreign K, you want to think about how much you're saving, what type of tax treatment you're going to save, and what are you going to invest in? Let's not overcomplicate it. That's really the only things we're looking at. But in terms of foreign Ks in general, here's some kind of stats that I looked up. So basically about 56% of the workforce has access to a foreign K plan. So everyone thinks, oh, foreign Ks are ubiquitous or they're everywhere. That's actually not the case. It's kind of the same thing with the whole pension argument. not as many people had pensions as you thought. So a lot of us are actually on our own when it comes to retirement savings in general. So just keep that in mind. There's an average of 28 investment options in a 401k plan. So it's not like we've got a million options, like, no, you can't invest in Bitcoin in a 401k.
Oh, come on.
I want that. Never. Yeah. And then about the number one investment option is a target date fund. So we're going to get a little bit about what those are, why they're fit, about... 43% of plant assets are actually in a target date fund. If you look at Vanguard study, just on Vanguard assets, it's almost 60%. Yeah, so most people just default to that. So it's important to know how they work and what they're on. And we can talk about that a little bit. Do you want to know how much we have saved by generation?
I would love that because again, we're really targeted millennials here. But yeah, what are people saving?
All right. So here's the thing. We got some work to do. Okay. So Gen Z, they're just starting out. So let's give them a break. Their average Our 401k balance is $7,100 and their mean is $2,500.
But they got time.
They got a little bit in there, but they got some ways to go. Us millennials, we've got $44,900 on average and only $15,500 mean.
Which is not good because again, I'm an elder millennial. and I'm 41, which means my time to retirement is not that long.
No. I mean, this is the point where if you're not saving yet, you need to put in a ton more than you would if you just started earlier. So if you're listening to this thing, I'm a little behind, like get going. Gen X, we're at 145,500 average and then 44,000 mean.
So they're doing a little bit better. Yeah. Not enough to live on though. That's not 20 years worth of savings for you in your retirement. Not at all. That's like one year.
Right. And boomers, quite frankly, they're not doing much better. They're at 215 average and then 61,000 mean. So that is not a lot to live on when you're going to retire in three weeks.
They all thought they were getting pensions, so.
They did. And they probably don't have them. So. We'll see. So that's kind of the current state. So clearly we have some work to do. The 401k is one option to help build up your wealth for retirement. So Kelly, do you want to ask a couple of questions? I know you had some questions.
I'm depleting this in that I feel like when we talk retirement, people automatically default to the 401k. Like, yeah, yeah, I got a 401k. And again, good option. But can you get a 401k if your employer doesn't offer it? Like, is that something that everybody should have a 401k or it's really, are you just using it if it's available from your employer?
So a 401k is an employer-driven plan. So it's only available if A, your employer offers it, or B, you're a solo practitioner, solopreneur, whatever you want to call it. You can set up your own. It's called a solo 401k. Those are really the only avenues to actually go get your own 401k plan. So if you're just working for so-and-so X, Y, Z company, and they don't have a plan, you cannot get a 401k. Okay.
Now what is... So I have a 401k. I'm putting money in it. Now... I think the biggest benefit that most of us know is your employer can put money in it as well. What drives that? What drives how much is put into these? How does that work with your employer?
So the employer typically will decide what you're referring to the match. And typically, there's two money types that go in there. I'm going to go into four. There's four money types. There's the money that you put in, that's considered the employee contribution. Then if an employer offers a match, not all of them do. They'll match either like dollar for dollar to X percentage or 50% to X percentage. Usually it's some cap amount. Then there's the profit sharing. So usually if it's a smaller business and the owner has a really good year, incentivizes the folks, say, all right, I'm going to dump some extra money in the plan. They'll do that for you. And then some plans, and this is where every plan is a little unique, so you have to read it and talk to a nerd like me that will actually read these documents and understand them. They offer what's called after tax. So that's above and beyond what you put in as an employee. you can actually put in after-tax money. So if you look at all four of those together, you can put it up to, in 2024, $69,000 a year into a 401k plan.
Oh, so you can't put whatever you want in there?
No, there's limits. So the employee part is $23,000.
Oh, I can only put $23,000. So if I want to save more than $23,000, then I have to have more than a 401k? Correct.
Or you have to be over $50,000, because then you get the catch-up, which is another $7,500 for this year. Or if they have, like I said, the after-tax option, you can get it up to 69 if you're doing that. But not a lot of plans out for the after-tax. It's pretty rare.
Now, what happens, I think for a lot of us, right, our parents'generations often started a job in their 20s and worked there for the rest of their career, right? So 40 years. That is not the same for millennials. We're kind of job hoppers. It's a hallmark of the millennial generation that we have hopped jobs. And you may have a collection of 401ks. So I, for example. if I was to count, most of them have been rolled over at this point, but I have had six different 401k plans, six different employers. Should we be leaving those at our former employer? Should we be rolling them over? Like, what do you do with these things? Because I think a lot of us just, it's living somewhere. It looks like it's making money. So we're like, not going to worry about that. But like, should I be rolling that in? Do I roll it into a new 401k? What do I do with that?
Well, so I'll just break down the, you basically have a few options when it comes to that. So option one is you can leave it in the. former employer's plan. Some of the downsides of that is like, let's say they go out of business or they move plans or the people you don't know don't work there anymore. They can be a lot harder to track. I don't love it leaving them there, but you can do that as an option. The other option is you could roll it into your new company's 401k plan. Almost every 401k plan is going to let you roll money into it. The other option that I hate is you could just take all the money out, but then you're paying taxes and a 10% penalty. So not necessarily the best choice. And then the fourth one is rolling the money into an individual retirement account. So you have Roth dollars, roll into Roth IRA. If you have traditional, roll into traditional IRA. There's some pros and cons to each. Like I mentioned, there's 28 investment options on average in a 401k plan. It's okay, but IRAs literally have endless amounts. So there's thousands of investment options.
Can I invest in Bitcoin?
Not in a 401k plan, but you probably could in an IRA. So it depends. Do you want more control over what you have? um the other kind of random thing that i'll bring up to people and usually no one says anything about it but it's creditor protected in a 401k plan it's not in an ira um and i did have a client where that actually did make some sense because he had a pharmacy and he's like you know in case anything ever happens with that um that's
one thing to look at is 401k assets are creditor protected creditor protected all right so what if i'm looking at 401k options you know i i have a 401k right now i my money comes out it goes into it I didn't really, I had to pick aggressive. slightly aggressive or less aggressive as my investment options. So it wasn't a lot of choices that I was getting. Should you have your, if you have an employer sponsored plan, should you have your financial advisor take a look at that documentation and help you choose even if they're not the one managing that plan?
Well, technically we're actually not really supposed to help them pick the options in the plan because we're not directly managing those. But I think it is worth coordinating the investment options with what you have outside of it in general.
So just have a conversation so everybody's on the same page. Now in the employer portion, now I think a lot of us, right, when we look at the balance of our 401k, like I open it up, I see monies, I'm like, look at all those monies, but they're not all mine.
No, you'll probably see two, three line items depending on how much tax you have. So you have your employee contribution. That's the money you put in. That money is always going to be 100% yours. So if you left three weeks after joining the employer, that money's always going to be yours. The other option is the employer match. And those typically will have a vesting schedule. Some of them don't. I'm not going to get too technical with it. But that's one thing you want to make sure you understand in your plan because some will have a three, four, five, up to a six-year vesting schedule. So it means you have to be at the employer for six years. And some are cliffs where, you know, maybe first two years you get nothing. And then all of a sudden you get 50% of it. And some will get 25% each year. So you just really want to make sure you understand when the employer gives you money, when is that officially yours.
And when can you take money out of a 401k?
While you're in the plan, there's not a ton of options. And this is, once again, going to be plan specific. But the general options you have are taking out as a loan, which we can get into. And then generally, some plans have hardship withdrawals. So there's a death, a disability, death of a family member, something like that, where you need to take some money out penalty free. They'll let you do that. Otherwise, if you just withdraw money, you're paying taxes and a 10% penalty.
Now, what age can you? get the money out of that on a regular basis without all these penalties.
Age 59 and a half is when you can officially get all that with all the penalty issues.
Half seems like a common age in the conversations we've had for retirement, right? 59 and a half is like, that's like the, I'm now a real grownup.
Yeah. I don't know how they pick that specific age considering everything else is 65 or social security even starts at 62. So I'm not sure exactly how they came up with a 59 and a half, but that's generally where, okay, now I can move money out. And a lot of times you could actually move money out while you're still working there. So if you have like my big kind of pet peeve with 401k plans, they generally have very mediocre options when it comes to actually taking income in retirement. Generally, there's like three bond funds and a stable value fund, which is basically a money market, which pays half as much interest as you would get like a high yield savings account. So you can actually take money out and do what's called an in-service distribution and get money to another IRA while you're still working. Because generally, you can't just roll over your 401k while you're still working to an IRA.
So let's talk about loans. A lot of us will see, especially we've covered in other episodes, that a lot of millennials don't have a lot of savings. We don't have a lot of emergency funds. So say I'm a millennial, but I have done well with my 401k. I've got $200,000 in there, but that's kind of my money. That's what I've got. And I want to buy a house, right? Here's your friendly neighborhood mortgage lady. And I want to borrow money from my 401k. Can I do that?
You can. So you can take a loan out for any reason. They're not going to ask you, like, what are you taking this money out for? But with a loan, there's definitely some things you want to watch out for. like once again, the plan documents will dictate like what you can take out, how much, but generally it's about 50% of what you have in there. So if you have 200,000, you can take a loan up for about a hundred thousand. Uh, everyone says, well, great. I'm paying myself interest, but you are taking money out of an account that is earning money hopefully, or is at least invested. Um, so that's, there's an opportunity cost associated with that. Uh, and the one thing I mentioned to you was, um, if you leave your employer, you're going to owe that money back right away. Oh, so if you take out a hundred thousand dollars and you say, yeah. I got my new house. I'm going to get a new job, my whole new life. Guess what? You got to pay that $100,000 back right away.
Now, what happens if you leave that 401k? Can you move the 401k while you have a loan on it?
Nope. No, you need to close out all debts before you can move that 401k.
This is good to know. Yeah. And I do have clients on the mortgage side that will take out 401k loans for things like down payments and stuff like that. And a lot of times they'll try to ask us, the lender, a lot of questions about it. And I always defer right back to you need to speak to the plan administrator. Because every 401k is a little bit different and the rules are a little bit different. And then that vested amount, a lot of times you can't borrow the employer contribution. And if you have an employer that's contributing a lot, a lot of what is in your plan may be an employer contribution and you can't necessarily touch those funds.
Yeah. Before you go the loan route, make sure you go through the plan document. Every plan is going to have a plan administrator. That may be someone in HR. That may be a financial advisor attached to it. That may be. They're called third-party administrators. There's going to be someone you could talk to that can outline the ramifications of the loan. And generally, there's a loan fee. It's not usually much. It's usually a couple hundred dollars. But just know that those are some of the issues you can run into with loans. Although I thought it was interesting what you were telling me about how loans are countered with mortgage with 401Ks. So I'd love to. Yeah.
People are looking for down payment money and they're trying to figure out ways to get down payment money, especially if you're selling, say you own two houses or you own one house, house A, and you're trying to buy house B before you sell house A. And that is a very common scenario right now is I want to buy a new house, but I don't want the seller of my new house to think that it's contingent upon the sale of my old house. So I need to borrow money for my down payment because I'm not necessarily going to close on my sale first. So people will turn to their 401k. So what's great about that on our end from the mortgage end is we don't count for a 401k loan as part of your debt to income, where if you were to take out any other type of loan that's somebody else's money, if you've got a $300 a month payment, that's $300 that's hit on your debt to income. And a lot of people will sometimes take out like home equity lines on their current home to use as a debt payment on their new home. Well, if it's a $300 a month payment, that's $300 that we're going to count. The reason why we don't use... that debt in a 401k loan is you are borrowing money from yourself. It's not another creditor. So if you were to theoretically not pay it back, you are just not paying yourself back. You are not, it's not another person whose money is owed to them.
Yeah. You're not defaulting on. Exactly. You know, they're not going to come after your house or other asset, right?
There's ramifications on the 401k, right? And there's ramifications. You're going to pay taxes. You're going to pay penalties. And honestly, I always tell people it costs a lot of money for to get that money if you don't do it correctly. but we don't count it in your debt to income because it's your own funds.
That's interesting. I never actually never heard of that. I mean, I'm in general just more conservative as a financial advisor. So I don't love the taking money out of loans, especially in that scenario where it's like really time because I know a lot of things can go wrong at closing. Yeah. Last minute, you never heard of like, oh, shoot, now I'm going to get the money back on day, you know, 90 or 98 or whatever. You're like, uh, what do I do about it?
Back into there right now.
Yeah. So that's, you know, I just generally. I generally, my thing is when you're thinking about how much do I put in the 401k, it should be for retirement. Like think this is my retirement money. And if you really need to save it for a house, I would still recommend, okay, let's, let's create an account for that. But I do understand, Hey, there's an opportunity where like, I have this house, I need a little extra money for it. It's going to really help my cashflow moving forward. You know, it can make some sense. I like that more than, Hey, I need to buy a car. I love this. You know, I don't know what you call Lexus or whatever you want to say. Like, I need to get this. I'm going to borrow my money for like, there's better assets to buy things with. The houses are one thing. Buying, taking loans out for things is probably not my favorite option.
Yeah. And I would agree with that too. I think for us on the lending side, it is a little bit of a last resort. Again, can be useful if you are on the younger side. I think it's less of a big deal. I have occasionally had people nearing retirement who are borrowing funds from their 401k. And that definitely gives me, you need that money making money at that point. You do. Yeah. You need that money making money. And as you said, there is a time cost in borrowing that money because you're taking it out of the market. You're taking it out of your investments. And like, what if there's a big upswing in the markets while the money's out, you didn't capitalize on that.
Right. Because the argument I always hear is, well, I'm paying my self-interest and the interest could be, I mean, I don't even know now, and that's probably 8% or 9% right now. So like, oh, cool. I'm earning 8.9%, but you're paying that. So it's not like it's free money. But if the money was in the market and the market goes up 20% that year, you lost 12%. Yeah,
exactly. So it's definitely something to contemplate. Now for these 401ks, you use the word vested and we... Didn't really get into that. What does vested mean? Like what is the definition of that? And why do I care if I'm vested or not other than me leaving my employer?
That's just essentially when the money becomes yours.
So it's not yours until that point.
Right. So the money you put in is always 100% vested. The money your employer puts in most of the time will have a schedule. Sometimes it doesn't, but that's where you need to understand how that works. Because some plans, they'll give you the money right away and it's yours day one.
Okay. So what if I take a loan out? Right. So I'm going to borrow money. I'm not fully vested. I am going to leave my employer. Now you said I owe that money back. Right. If I leave my employer. What are the penalties for this? Because that's the part like that I think people don't get is if you're paying, it's not just the 10 percent penalty. You're also paying taxes.
Yeah. It's going to they're going to basically treat it as you taking the money out.
It's gone. Right. Correct. And you're not going to get it back. Correct. So that could be that could be. big financial hit for people.
Especially depending on your tax bracket. So there's a whole lot of issues you really wanna be aware of, okay, like if X, Y, Z happens, you know, what do I do? So it's good, you know, go for the loan, that's fine. Just make sure, okay, if it hits the fan, what am I doing?
Now, employer contribution-wise, should you be maybe checking? that what that is before you accept jobs like is that something that should be a part of your contemplation if you're looking at job a and job b and one match is six percent and one i'm going to use nine which derek will laugh about i i work at used to work at an employer that matched nine percent um and it was like unheard of i know i'm gonna faint over here it's crazy nine percent it was nine percent and my fun fact is i did not contribute to that 401k for the first three years that i worked for this and you didn't have to put nine percent in to get the nine right put six six Cool. Yeah. It was a big money waster. It was a big money waster. But again, I think especially, and this is probably those Gen Zers, is when you're in your early 20s, first off, retirement seems a thousand years away, right? So for me, when I was in my 20s, I think they were taking like $50 out of my paycheck. But at that time, I was like 24, $50 in my pocket felt like so much more than $50 in my retirement. And if I had ever understood what that money meant to me today, I would have happily given them my $50. But I mean,
that meant $75 was going in for you on top of that.
On top of that. Yeah. And I just didn't understand that. And what's that money now 20 years later? Like lots of money.
Yeah. I think it's important to put a little perspective too, because a lot of people think a lot of, unfortunately, when you read the documents, it's always percentages. So it's like, oh, it's 6% of the salary, 3%. But if you're like, all right, let's be real here. If you make $50,000, 3% is $1,500 a year.
Which is not a lot.
It's not. Crazy. It's a little over a hundred dollars a month. So it's not like, oh my God, for sure, almost all of us can find a hundred dollars a month somewhere, even 50. Right. So the fact that they're going to double that money for you, now you have $300 going to your account every single month.
Yeah. What could you be doing with that in 20 years?
Right. And so it's, it's, um, you know, basically I think the stat is if you started at 25, you need like $581 or something along those lines to get a million by the time you're 65.
Well, and a million, I think we talked about this on an earlier episode, like. A million sounds like a lot. That's the minimum that most people need in retirement. Like a million will get you like continuing to live the lifestyle you've been living while you're employed and some of your health care costs covered. But you're not on a yacht at a million dollars in retirement like living the high life. Your life is OK. You're paying your bills. But you have to live on that, especially because people are living longer and longer with more health care costs. If you're retiring at 65 and you live to be 95.
Good luck.
A million dollars for that length of time does not go very far. No.
Well, you know, one point I want to make about the match, because I think it's the biggest missed opportunity I see, because folks that aren't taking advantage of it, it just drives me nuts, because you're automatically getting a 100% rate of return in most cases. You got a 150% rate of return. Yeah,
but it didn't do it.
On average, the stock market earns 10. So you're doing 10 times what the stock market does with no risk, because the employer is just throwing money at you. So now you're compounding that plus a 10% on top of that. It's such a missed opportunity. And it's like if I gave you $100 or you gave me $100 and I said, all right, here's $200 back. You do that all day.
All day long. I'd be like, sure, here you go.
Yeah, why not? The only difference is it goes into a different account that you can't touch for a little while, which I get is probably annoying. But it's such an opportunity to make an extra wealth.
Now, what if your employer doesn't match? Is it still worth it to have a 401k?
Generally, it is because it depends on your situation. But especially for higher income earners, it's... and your W-2, it's going to be one of the only tax vehicles you have. Because when you make too much money, you get phased out of a Roth. When you make too much money, you're going to have a tax problem, right? So the pre-tax piece of it's going to be really important for you. And if you're doing both, you can actually do a backdoor Roth with a pre-tax. So you can really probably get a little weeds here, but basically you can-Backdoor Roth. I don't know who names these things. Yeah. But basically you can leverage that as a tool. And a lot of people are like, oh, it's a scam. You see the stuff online now. It's like, don't do this. Do this instead. Invest in real estate. It's like, okay, let's take a break here. If you're not getting a match, it's still a good vehicle to use because you are getting that tax treatment. Just be frank. W-2 people do not have tax deductions. Good luck.
Yeah,
no. You don't open an LLC for a W-2 person. You can't just do all this stuff you hear on TikTok, right? So you do need that option to say, okay, I'm going to put some money in here. It's going to be my retirement account. This should not be, across the board, the only thing you save for retirement. because you are locking your money up. But it's a good tool to just kind of save automatically. I mean, for most of us, we're just terrible at saving in general. So having something that automatically comes out of our paycheck is really important too.
Yeah, right. Well, and that's it, right? It's the set it or forget it. It goes out. You don't even think about it. You're not moving it. That's what I like about the 401k is that it's like what I don't see, I don't know. It just comes out of my pay. Mine is a percentage that I put in. So it's base and I'm commission-based. So my... paychecks look very different every month, but it's a percentage. So some months it's a lot, some months it's not, but months that I get paid a lot, it's a lot of money. Cool. It's gone. I didn't even know that I got it. Right.
And you know, the other beauty of it too, is the market's going to fluctuate. So it's going to be up and down. So the nice thing is because you're putting money in every paycheck, which is every week, bi-weekly, whatever, you're going to write out, you know, you're going to kind of, I don't know. The gains aren't going to be as bad and the loss aren't going to be as bad either because you're buying things at a discount. You're buying things, you're buying less when the market's up. So it's going to even out your returns over time because you're being more consistent with it. Instead of being like, oh, yeah, I have an extra $50 after saving for three months. I'm going to dump a bunch of money in all at once and try and time the market that way. This is just boom, consistent, every single paycheck, money's going in the market and the market goes up. Great. If it goes down, even better because now I get things at a discount.
Yeah. And I'm one of those people where I'm not allowed to look at my 401k. because I get very wrapped up and like it went down and my husband's like, stop looking at it.
I wish I can get everyone to realize that. The best actual course of action for the market just suck until you're like five years before you retire and have a shoot up. That would be ideal because now you're buying things as cheap. Like you actually don't really want your, if you're younger, you don't want your balance to go up as much. You just want to put more money in it all the time because you're buying things at a discount.
Yeah. So it's getting a little better. So any last minute thoughts for people on a 401k, any tips, tricks, things they should know?
Actually one, one big thing I think we kind of didn't talk about it, which I mentioned earlier is a target date funds, right? Cause that's, that's the number one investment that most people have. And most people aren't really familiar with how they work. And I'll just give a quick primer on that because basically it's going to take your age when you think you're going to retire and it's going to be aggressive now. So more stocks over bonds. And as you get closer to retirement, it's going to be a little bit more conservative. One thing to watch out for, there are two types. And this is going to be a little technical here, but it's basically there's a through glide path and a to glide path.
That sounds a little Spanish.
You're like, what is happening?
What does that even mean? Derek right now.
And I'm going to explain it. So basically. A lot of people are like, oh, my target date sucks. I lost all this money in 2008. It's because they had a through glide path. They assume you're going to retire at 65, but your retirement's going to last 20 plus years. So we're going to stay aggressive. So people thought they were really conservative when they retire,
actually weren't.
And the two one says, okay, you're going to retire at 65. We're going to be conservative at retirement. So I think it's very important to understand which one you're in.
And now do you choose that when you set up your 401k?
So your employer chooses the, and each targeted company does it differently. Like Vanguard will do it differently than American funds or Fidelity. So you just really want to look at, you know, the easiest way to do it is kind of look at like a targeted, like 2020 or 2019 or 2015 fund to see where they are from an allocation standpoint. And it'll tell you if it's two or three. But it's a small thing that people probably don't think about, but if you're at 60 years old and you've got five years of retirement, like, do you really want to be that aggressive? Maybe you do. I don't know, but.
you know just something to watch out for because that's something that people don't realize they think they're conservative they're not oh i would have no idea so it's often very overlooked like i know it's a little nerdy but it's uh it's important to understand how that works and how you're saving well this is why having like a great financial advisor as a partner i think is so important because again even if they can't advise you on your particular plan someone to ask questions of so you understand what options you have and you understand like what am I signing myself up for? What do these words mean? Because I've never heard that before. And again, educated financial professional here, that was a whole different language to me. So I appreciate that.
Yeah. We have our own language over here. Yeah.
That's true. Well, listen, so do mortgage people. So it's part of the deal. And that's what we're here for, to educate people about all this stuff that nobody tells you about.
Yeah. So I mean, that's all I really have to talk about with the 401k plans. I think they're once again, the great tool, not the only thing I would ever invest in. But definitely a useful thing from a tax standpoint, from a savings standpoint. And get that free money because it's out there.
Get that free money from your employer, especially because you've earned it.
You have. Yep. It's part of the comp plan.
There you go. All right. Well, thanks for listening.
Yeah. Talk to you soon.
The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, Consult the appropriate qualified professional prior to making a decision. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies. Investing involves risks, including possible loss of principle.
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Description
401ks are the top retirement account out there. Millennials every day make contributions to a plan they barely understand. In this episode of Millennial Money Matters, we delve into the mysterious world of 401k plans. We discuss the three main decisions you make with 401k plans, how target date fund works, 401k rules and many more. If you have many questions about 401k plans, this episode is for you.
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Transcription
Here we are for another episode of Millennial Money Matters with Derek and Kelly. Kelly, how you doing?
I'm doing great. I'm doing great. How was your weekend?
I am still recovering. I was, my wife was on a girl's trip for four days and this is day four and I am glad she's coming back today.
And so you've been alone with two kids for four days?
Yep, they are five and three, two boys, so they have endless energy. We did probably, I think, Six different activities, like going out of the house, going to different houses, going to the science museum, going to birthday parties. T-ball pictures, which was a cluster.
Oh, I was also at T-ball pictures. I saw you also. And that was chaos.
Yeah. There's just bats everywhere. Yes. Kids everywhere.
Small five-year-old swinging bats indoors. Yeah,
what could go wrong?
Yeah, we were there for double duty because we have two kids in baseball. So my husband was... at Baseball Pictures from 10 a.m. until almost noon.
Well, he's a coach, so he's obviously very important.
Yeah, very, very important. Yeah, no, that was an adventure. But yeah, four days with your kids, no matter what. That's a lot of days alone.
You know, I get a lot of credit for single parents out there because I think when you're kind of in that realm of used to doing this, you kind of have a rhythm. We don't have that rhythm yet. So if kids want to stay out late, they're like, Dad, can we do a little fort over the bed? I'm like, I don't know how we're going to possibly do this. You know, they want to sleep in the same bed and they don't. Yeah, it's fun.
Well, and then you also had the surprise rain on Saturday. Saturday was supposed to be beautiful. And then it rained from the moment we woke up until the moment we went to bed.
Kids and rain is always the best combination.
We were supposed to have two baseball games that day. Both got canceled. Both got canceled at the last minute. And we were like, now what?
Yeah, I know.
What are we supposed to do with you? We had plans. They're over now.
I tell you, we bought a bounce house for Christmas a couple years ago. And it's small enough to fit in our basement. It's been the best decision ever. Because with these winters in New England, you're just like, get in the basement. Get some energy.
Go jump in the bounce. Yeah. That's a good call. We have an inflatable water slide. So that's our summer activity, which also 10 out of 10 stars would recommend. Okay.
All right. See, you come for money tips, but here you get parenting tips. Correct.
Because this is Millennial Money Matters and lots of us millennials are dealing with children.
We are. Yeah. So what's our topic today, Kel?
Our topic today is 401ks. And I love this. Part of Derek and I's exploration of doing these podcasts are we have discussions about these topics. And 401ks are... I feel like a bit of a mystery to a lot of us in that our parents are not always the most helpful in educating us on 401ks because they come from the era of pensions.
They do. Yeah.
How's your pension? You're like, nobody's had a pension in 20 years.
Get a job with a pension. Where? Where? Government. That's about it.
But even the government, it's not super common these days.
They're getting worse. I have some clients in the other age of this pension program that work for the state of Connecticut here. And the ones that are about to retire are looking pretty. The younger folks, it's going to be a little dicey.
I see. So 401k is definitely more common. I think that there's a lot of myth around it. And even I, like as Derek and I chatted about this and I had questions and he's like, no, that's not true. No, that's not true. So I'm an educated financial professional and still don't necessarily know a lot about 401k. So tell me a little bit, Derek, like what's, give me some basic facts about a 401k.
First of all, your impression of me was spot on. I just want to point that out. Yeah, that was amazing. Well, you know, I always tell clients there's really three main things you need to worry about with a foreign K in general, and then I'll get to some crazy stats we have. But really when it comes to your decision on a foreign K, you want to think about how much you're saving, what type of tax treatment you're going to save, and what are you going to invest in? Let's not overcomplicate it. That's really the only things we're looking at. But in terms of foreign Ks in general, here's some kind of stats that I looked up. So basically about 56% of the workforce has access to a foreign K plan. So everyone thinks, oh, foreign Ks are ubiquitous or they're everywhere. That's actually not the case. It's kind of the same thing with the whole pension argument. not as many people had pensions as you thought. So a lot of us are actually on our own when it comes to retirement savings in general. So just keep that in mind. There's an average of 28 investment options in a 401k plan. So it's not like we've got a million options, like, no, you can't invest in Bitcoin in a 401k.
Oh, come on.
I want that. Never. Yeah. And then about the number one investment option is a target date fund. So we're going to get a little bit about what those are, why they're fit, about... 43% of plant assets are actually in a target date fund. If you look at Vanguard study, just on Vanguard assets, it's almost 60%. Yeah, so most people just default to that. So it's important to know how they work and what they're on. And we can talk about that a little bit. Do you want to know how much we have saved by generation?
I would love that because again, we're really targeted millennials here. But yeah, what are people saving?
All right. So here's the thing. We got some work to do. Okay. So Gen Z, they're just starting out. So let's give them a break. Their average Our 401k balance is $7,100 and their mean is $2,500.
But they got time.
They got a little bit in there, but they got some ways to go. Us millennials, we've got $44,900 on average and only $15,500 mean.
Which is not good because again, I'm an elder millennial. and I'm 41, which means my time to retirement is not that long.
No. I mean, this is the point where if you're not saving yet, you need to put in a ton more than you would if you just started earlier. So if you're listening to this thing, I'm a little behind, like get going. Gen X, we're at 145,500 average and then 44,000 mean.
So they're doing a little bit better. Yeah. Not enough to live on though. That's not 20 years worth of savings for you in your retirement. Not at all. That's like one year.
Right. And boomers, quite frankly, they're not doing much better. They're at 215 average and then 61,000 mean. So that is not a lot to live on when you're going to retire in three weeks.
They all thought they were getting pensions, so.
They did. And they probably don't have them. So. We'll see. So that's kind of the current state. So clearly we have some work to do. The 401k is one option to help build up your wealth for retirement. So Kelly, do you want to ask a couple of questions? I know you had some questions.
I'm depleting this in that I feel like when we talk retirement, people automatically default to the 401k. Like, yeah, yeah, I got a 401k. And again, good option. But can you get a 401k if your employer doesn't offer it? Like, is that something that everybody should have a 401k or it's really, are you just using it if it's available from your employer?
So a 401k is an employer-driven plan. So it's only available if A, your employer offers it, or B, you're a solo practitioner, solopreneur, whatever you want to call it. You can set up your own. It's called a solo 401k. Those are really the only avenues to actually go get your own 401k plan. So if you're just working for so-and-so X, Y, Z company, and they don't have a plan, you cannot get a 401k. Okay.
Now what is... So I have a 401k. I'm putting money in it. Now... I think the biggest benefit that most of us know is your employer can put money in it as well. What drives that? What drives how much is put into these? How does that work with your employer?
So the employer typically will decide what you're referring to the match. And typically, there's two money types that go in there. I'm going to go into four. There's four money types. There's the money that you put in, that's considered the employee contribution. Then if an employer offers a match, not all of them do. They'll match either like dollar for dollar to X percentage or 50% to X percentage. Usually it's some cap amount. Then there's the profit sharing. So usually if it's a smaller business and the owner has a really good year, incentivizes the folks, say, all right, I'm going to dump some extra money in the plan. They'll do that for you. And then some plans, and this is where every plan is a little unique, so you have to read it and talk to a nerd like me that will actually read these documents and understand them. They offer what's called after tax. So that's above and beyond what you put in as an employee. you can actually put in after-tax money. So if you look at all four of those together, you can put it up to, in 2024, $69,000 a year into a 401k plan.
Oh, so you can't put whatever you want in there?
No, there's limits. So the employee part is $23,000.
Oh, I can only put $23,000. So if I want to save more than $23,000, then I have to have more than a 401k? Correct.
Or you have to be over $50,000, because then you get the catch-up, which is another $7,500 for this year. Or if they have, like I said, the after-tax option, you can get it up to 69 if you're doing that. But not a lot of plans out for the after-tax. It's pretty rare.
Now, what happens, I think for a lot of us, right, our parents'generations often started a job in their 20s and worked there for the rest of their career, right? So 40 years. That is not the same for millennials. We're kind of job hoppers. It's a hallmark of the millennial generation that we have hopped jobs. And you may have a collection of 401ks. So I, for example. if I was to count, most of them have been rolled over at this point, but I have had six different 401k plans, six different employers. Should we be leaving those at our former employer? Should we be rolling them over? Like, what do you do with these things? Because I think a lot of us just, it's living somewhere. It looks like it's making money. So we're like, not going to worry about that. But like, should I be rolling that in? Do I roll it into a new 401k? What do I do with that?
Well, so I'll just break down the, you basically have a few options when it comes to that. So option one is you can leave it in the. former employer's plan. Some of the downsides of that is like, let's say they go out of business or they move plans or the people you don't know don't work there anymore. They can be a lot harder to track. I don't love it leaving them there, but you can do that as an option. The other option is you could roll it into your new company's 401k plan. Almost every 401k plan is going to let you roll money into it. The other option that I hate is you could just take all the money out, but then you're paying taxes and a 10% penalty. So not necessarily the best choice. And then the fourth one is rolling the money into an individual retirement account. So you have Roth dollars, roll into Roth IRA. If you have traditional, roll into traditional IRA. There's some pros and cons to each. Like I mentioned, there's 28 investment options on average in a 401k plan. It's okay, but IRAs literally have endless amounts. So there's thousands of investment options.
Can I invest in Bitcoin?
Not in a 401k plan, but you probably could in an IRA. So it depends. Do you want more control over what you have? um the other kind of random thing that i'll bring up to people and usually no one says anything about it but it's creditor protected in a 401k plan it's not in an ira um and i did have a client where that actually did make some sense because he had a pharmacy and he's like you know in case anything ever happens with that um that's
one thing to look at is 401k assets are creditor protected creditor protected all right so what if i'm looking at 401k options you know i i have a 401k right now i my money comes out it goes into it I didn't really, I had to pick aggressive. slightly aggressive or less aggressive as my investment options. So it wasn't a lot of choices that I was getting. Should you have your, if you have an employer sponsored plan, should you have your financial advisor take a look at that documentation and help you choose even if they're not the one managing that plan?
Well, technically we're actually not really supposed to help them pick the options in the plan because we're not directly managing those. But I think it is worth coordinating the investment options with what you have outside of it in general.
So just have a conversation so everybody's on the same page. Now in the employer portion, now I think a lot of us, right, when we look at the balance of our 401k, like I open it up, I see monies, I'm like, look at all those monies, but they're not all mine.
No, you'll probably see two, three line items depending on how much tax you have. So you have your employee contribution. That's the money you put in. That money is always going to be 100% yours. So if you left three weeks after joining the employer, that money's always going to be yours. The other option is the employer match. And those typically will have a vesting schedule. Some of them don't. I'm not going to get too technical with it. But that's one thing you want to make sure you understand in your plan because some will have a three, four, five, up to a six-year vesting schedule. So it means you have to be at the employer for six years. And some are cliffs where, you know, maybe first two years you get nothing. And then all of a sudden you get 50% of it. And some will get 25% each year. So you just really want to make sure you understand when the employer gives you money, when is that officially yours.
And when can you take money out of a 401k?
While you're in the plan, there's not a ton of options. And this is, once again, going to be plan specific. But the general options you have are taking out as a loan, which we can get into. And then generally, some plans have hardship withdrawals. So there's a death, a disability, death of a family member, something like that, where you need to take some money out penalty free. They'll let you do that. Otherwise, if you just withdraw money, you're paying taxes and a 10% penalty.
Now, what age can you? get the money out of that on a regular basis without all these penalties.
Age 59 and a half is when you can officially get all that with all the penalty issues.
Half seems like a common age in the conversations we've had for retirement, right? 59 and a half is like, that's like the, I'm now a real grownup.
Yeah. I don't know how they pick that specific age considering everything else is 65 or social security even starts at 62. So I'm not sure exactly how they came up with a 59 and a half, but that's generally where, okay, now I can move money out. And a lot of times you could actually move money out while you're still working there. So if you have like my big kind of pet peeve with 401k plans, they generally have very mediocre options when it comes to actually taking income in retirement. Generally, there's like three bond funds and a stable value fund, which is basically a money market, which pays half as much interest as you would get like a high yield savings account. So you can actually take money out and do what's called an in-service distribution and get money to another IRA while you're still working. Because generally, you can't just roll over your 401k while you're still working to an IRA.
So let's talk about loans. A lot of us will see, especially we've covered in other episodes, that a lot of millennials don't have a lot of savings. We don't have a lot of emergency funds. So say I'm a millennial, but I have done well with my 401k. I've got $200,000 in there, but that's kind of my money. That's what I've got. And I want to buy a house, right? Here's your friendly neighborhood mortgage lady. And I want to borrow money from my 401k. Can I do that?
You can. So you can take a loan out for any reason. They're not going to ask you, like, what are you taking this money out for? But with a loan, there's definitely some things you want to watch out for. like once again, the plan documents will dictate like what you can take out, how much, but generally it's about 50% of what you have in there. So if you have 200,000, you can take a loan up for about a hundred thousand. Uh, everyone says, well, great. I'm paying myself interest, but you are taking money out of an account that is earning money hopefully, or is at least invested. Um, so that's, there's an opportunity cost associated with that. Uh, and the one thing I mentioned to you was, um, if you leave your employer, you're going to owe that money back right away. Oh, so if you take out a hundred thousand dollars and you say, yeah. I got my new house. I'm going to get a new job, my whole new life. Guess what? You got to pay that $100,000 back right away.
Now, what happens if you leave that 401k? Can you move the 401k while you have a loan on it?
Nope. No, you need to close out all debts before you can move that 401k.
This is good to know. Yeah. And I do have clients on the mortgage side that will take out 401k loans for things like down payments and stuff like that. And a lot of times they'll try to ask us, the lender, a lot of questions about it. And I always defer right back to you need to speak to the plan administrator. Because every 401k is a little bit different and the rules are a little bit different. And then that vested amount, a lot of times you can't borrow the employer contribution. And if you have an employer that's contributing a lot, a lot of what is in your plan may be an employer contribution and you can't necessarily touch those funds.
Yeah. Before you go the loan route, make sure you go through the plan document. Every plan is going to have a plan administrator. That may be someone in HR. That may be a financial advisor attached to it. That may be. They're called third-party administrators. There's going to be someone you could talk to that can outline the ramifications of the loan. And generally, there's a loan fee. It's not usually much. It's usually a couple hundred dollars. But just know that those are some of the issues you can run into with loans. Although I thought it was interesting what you were telling me about how loans are countered with mortgage with 401Ks. So I'd love to. Yeah.
People are looking for down payment money and they're trying to figure out ways to get down payment money, especially if you're selling, say you own two houses or you own one house, house A, and you're trying to buy house B before you sell house A. And that is a very common scenario right now is I want to buy a new house, but I don't want the seller of my new house to think that it's contingent upon the sale of my old house. So I need to borrow money for my down payment because I'm not necessarily going to close on my sale first. So people will turn to their 401k. So what's great about that on our end from the mortgage end is we don't count for a 401k loan as part of your debt to income, where if you were to take out any other type of loan that's somebody else's money, if you've got a $300 a month payment, that's $300 that's hit on your debt to income. And a lot of people will sometimes take out like home equity lines on their current home to use as a debt payment on their new home. Well, if it's a $300 a month payment, that's $300 that we're going to count. The reason why we don't use... that debt in a 401k loan is you are borrowing money from yourself. It's not another creditor. So if you were to theoretically not pay it back, you are just not paying yourself back. You are not, it's not another person whose money is owed to them.
Yeah. You're not defaulting on. Exactly. You know, they're not going to come after your house or other asset, right?
There's ramifications on the 401k, right? And there's ramifications. You're going to pay taxes. You're going to pay penalties. And honestly, I always tell people it costs a lot of money for to get that money if you don't do it correctly. but we don't count it in your debt to income because it's your own funds.
That's interesting. I never actually never heard of that. I mean, I'm in general just more conservative as a financial advisor. So I don't love the taking money out of loans, especially in that scenario where it's like really time because I know a lot of things can go wrong at closing. Yeah. Last minute, you never heard of like, oh, shoot, now I'm going to get the money back on day, you know, 90 or 98 or whatever. You're like, uh, what do I do about it?
Back into there right now.
Yeah. So that's, you know, I just generally. I generally, my thing is when you're thinking about how much do I put in the 401k, it should be for retirement. Like think this is my retirement money. And if you really need to save it for a house, I would still recommend, okay, let's, let's create an account for that. But I do understand, Hey, there's an opportunity where like, I have this house, I need a little extra money for it. It's going to really help my cashflow moving forward. You know, it can make some sense. I like that more than, Hey, I need to buy a car. I love this. You know, I don't know what you call Lexus or whatever you want to say. Like, I need to get this. I'm going to borrow my money for like, there's better assets to buy things with. The houses are one thing. Buying, taking loans out for things is probably not my favorite option.
Yeah. And I would agree with that too. I think for us on the lending side, it is a little bit of a last resort. Again, can be useful if you are on the younger side. I think it's less of a big deal. I have occasionally had people nearing retirement who are borrowing funds from their 401k. And that definitely gives me, you need that money making money at that point. You do. Yeah. You need that money making money. And as you said, there is a time cost in borrowing that money because you're taking it out of the market. You're taking it out of your investments. And like, what if there's a big upswing in the markets while the money's out, you didn't capitalize on that.
Right. Because the argument I always hear is, well, I'm paying my self-interest and the interest could be, I mean, I don't even know now, and that's probably 8% or 9% right now. So like, oh, cool. I'm earning 8.9%, but you're paying that. So it's not like it's free money. But if the money was in the market and the market goes up 20% that year, you lost 12%. Yeah,
exactly. So it's definitely something to contemplate. Now for these 401ks, you use the word vested and we... Didn't really get into that. What does vested mean? Like what is the definition of that? And why do I care if I'm vested or not other than me leaving my employer?
That's just essentially when the money becomes yours.
So it's not yours until that point.
Right. So the money you put in is always 100% vested. The money your employer puts in most of the time will have a schedule. Sometimes it doesn't, but that's where you need to understand how that works. Because some plans, they'll give you the money right away and it's yours day one.
Okay. So what if I take a loan out? Right. So I'm going to borrow money. I'm not fully vested. I am going to leave my employer. Now you said I owe that money back. Right. If I leave my employer. What are the penalties for this? Because that's the part like that I think people don't get is if you're paying, it's not just the 10 percent penalty. You're also paying taxes.
Yeah. It's going to they're going to basically treat it as you taking the money out.
It's gone. Right. Correct. And you're not going to get it back. Correct. So that could be that could be. big financial hit for people.
Especially depending on your tax bracket. So there's a whole lot of issues you really wanna be aware of, okay, like if X, Y, Z happens, you know, what do I do? So it's good, you know, go for the loan, that's fine. Just make sure, okay, if it hits the fan, what am I doing?
Now, employer contribution-wise, should you be maybe checking? that what that is before you accept jobs like is that something that should be a part of your contemplation if you're looking at job a and job b and one match is six percent and one i'm going to use nine which derek will laugh about i i work at used to work at an employer that matched nine percent um and it was like unheard of i know i'm gonna faint over here it's crazy nine percent it was nine percent and my fun fact is i did not contribute to that 401k for the first three years that i worked for this and you didn't have to put nine percent in to get the nine right put six six Cool. Yeah. It was a big money waster. It was a big money waster. But again, I think especially, and this is probably those Gen Zers, is when you're in your early 20s, first off, retirement seems a thousand years away, right? So for me, when I was in my 20s, I think they were taking like $50 out of my paycheck. But at that time, I was like 24, $50 in my pocket felt like so much more than $50 in my retirement. And if I had ever understood what that money meant to me today, I would have happily given them my $50. But I mean,
that meant $75 was going in for you on top of that.
On top of that. Yeah. And I just didn't understand that. And what's that money now 20 years later? Like lots of money.
Yeah. I think it's important to put a little perspective too, because a lot of people think a lot of, unfortunately, when you read the documents, it's always percentages. So it's like, oh, it's 6% of the salary, 3%. But if you're like, all right, let's be real here. If you make $50,000, 3% is $1,500 a year.
Which is not a lot.
It's not. Crazy. It's a little over a hundred dollars a month. So it's not like, oh my God, for sure, almost all of us can find a hundred dollars a month somewhere, even 50. Right. So the fact that they're going to double that money for you, now you have $300 going to your account every single month.
Yeah. What could you be doing with that in 20 years?
Right. And so it's, it's, um, you know, basically I think the stat is if you started at 25, you need like $581 or something along those lines to get a million by the time you're 65.
Well, and a million, I think we talked about this on an earlier episode, like. A million sounds like a lot. That's the minimum that most people need in retirement. Like a million will get you like continuing to live the lifestyle you've been living while you're employed and some of your health care costs covered. But you're not on a yacht at a million dollars in retirement like living the high life. Your life is OK. You're paying your bills. But you have to live on that, especially because people are living longer and longer with more health care costs. If you're retiring at 65 and you live to be 95.
Good luck.
A million dollars for that length of time does not go very far. No.
Well, you know, one point I want to make about the match, because I think it's the biggest missed opportunity I see, because folks that aren't taking advantage of it, it just drives me nuts, because you're automatically getting a 100% rate of return in most cases. You got a 150% rate of return. Yeah,
but it didn't do it.
On average, the stock market earns 10. So you're doing 10 times what the stock market does with no risk, because the employer is just throwing money at you. So now you're compounding that plus a 10% on top of that. It's such a missed opportunity. And it's like if I gave you $100 or you gave me $100 and I said, all right, here's $200 back. You do that all day.
All day long. I'd be like, sure, here you go.
Yeah, why not? The only difference is it goes into a different account that you can't touch for a little while, which I get is probably annoying. But it's such an opportunity to make an extra wealth.
Now, what if your employer doesn't match? Is it still worth it to have a 401k?
Generally, it is because it depends on your situation. But especially for higher income earners, it's... and your W-2, it's going to be one of the only tax vehicles you have. Because when you make too much money, you get phased out of a Roth. When you make too much money, you're going to have a tax problem, right? So the pre-tax piece of it's going to be really important for you. And if you're doing both, you can actually do a backdoor Roth with a pre-tax. So you can really probably get a little weeds here, but basically you can-Backdoor Roth. I don't know who names these things. Yeah. But basically you can leverage that as a tool. And a lot of people are like, oh, it's a scam. You see the stuff online now. It's like, don't do this. Do this instead. Invest in real estate. It's like, okay, let's take a break here. If you're not getting a match, it's still a good vehicle to use because you are getting that tax treatment. Just be frank. W-2 people do not have tax deductions. Good luck.
Yeah,
no. You don't open an LLC for a W-2 person. You can't just do all this stuff you hear on TikTok, right? So you do need that option to say, okay, I'm going to put some money in here. It's going to be my retirement account. This should not be, across the board, the only thing you save for retirement. because you are locking your money up. But it's a good tool to just kind of save automatically. I mean, for most of us, we're just terrible at saving in general. So having something that automatically comes out of our paycheck is really important too.
Yeah, right. Well, and that's it, right? It's the set it or forget it. It goes out. You don't even think about it. You're not moving it. That's what I like about the 401k is that it's like what I don't see, I don't know. It just comes out of my pay. Mine is a percentage that I put in. So it's base and I'm commission-based. So my... paychecks look very different every month, but it's a percentage. So some months it's a lot, some months it's not, but months that I get paid a lot, it's a lot of money. Cool. It's gone. I didn't even know that I got it. Right.
And you know, the other beauty of it too, is the market's going to fluctuate. So it's going to be up and down. So the nice thing is because you're putting money in every paycheck, which is every week, bi-weekly, whatever, you're going to write out, you know, you're going to kind of, I don't know. The gains aren't going to be as bad and the loss aren't going to be as bad either because you're buying things at a discount. You're buying things, you're buying less when the market's up. So it's going to even out your returns over time because you're being more consistent with it. Instead of being like, oh, yeah, I have an extra $50 after saving for three months. I'm going to dump a bunch of money in all at once and try and time the market that way. This is just boom, consistent, every single paycheck, money's going in the market and the market goes up. Great. If it goes down, even better because now I get things at a discount.
Yeah. And I'm one of those people where I'm not allowed to look at my 401k. because I get very wrapped up and like it went down and my husband's like, stop looking at it.
I wish I can get everyone to realize that. The best actual course of action for the market just suck until you're like five years before you retire and have a shoot up. That would be ideal because now you're buying things as cheap. Like you actually don't really want your, if you're younger, you don't want your balance to go up as much. You just want to put more money in it all the time because you're buying things at a discount.
Yeah. So it's getting a little better. So any last minute thoughts for people on a 401k, any tips, tricks, things they should know?
Actually one, one big thing I think we kind of didn't talk about it, which I mentioned earlier is a target date funds, right? Cause that's, that's the number one investment that most people have. And most people aren't really familiar with how they work. And I'll just give a quick primer on that because basically it's going to take your age when you think you're going to retire and it's going to be aggressive now. So more stocks over bonds. And as you get closer to retirement, it's going to be a little bit more conservative. One thing to watch out for, there are two types. And this is going to be a little technical here, but it's basically there's a through glide path and a to glide path.
That sounds a little Spanish.
You're like, what is happening?
What does that even mean? Derek right now.
And I'm going to explain it. So basically. A lot of people are like, oh, my target date sucks. I lost all this money in 2008. It's because they had a through glide path. They assume you're going to retire at 65, but your retirement's going to last 20 plus years. So we're going to stay aggressive. So people thought they were really conservative when they retire,
actually weren't.
And the two one says, okay, you're going to retire at 65. We're going to be conservative at retirement. So I think it's very important to understand which one you're in.
And now do you choose that when you set up your 401k?
So your employer chooses the, and each targeted company does it differently. Like Vanguard will do it differently than American funds or Fidelity. So you just really want to look at, you know, the easiest way to do it is kind of look at like a targeted, like 2020 or 2019 or 2015 fund to see where they are from an allocation standpoint. And it'll tell you if it's two or three. But it's a small thing that people probably don't think about, but if you're at 60 years old and you've got five years of retirement, like, do you really want to be that aggressive? Maybe you do. I don't know, but.
you know just something to watch out for because that's something that people don't realize they think they're conservative they're not oh i would have no idea so it's often very overlooked like i know it's a little nerdy but it's uh it's important to understand how that works and how you're saving well this is why having like a great financial advisor as a partner i think is so important because again even if they can't advise you on your particular plan someone to ask questions of so you understand what options you have and you understand like what am I signing myself up for? What do these words mean? Because I've never heard that before. And again, educated financial professional here, that was a whole different language to me. So I appreciate that.
Yeah. We have our own language over here. Yeah.
That's true. Well, listen, so do mortgage people. So it's part of the deal. And that's what we're here for, to educate people about all this stuff that nobody tells you about.
Yeah. So I mean, that's all I really have to talk about with the 401k plans. I think they're once again, the great tool, not the only thing I would ever invest in. But definitely a useful thing from a tax standpoint, from a savings standpoint. And get that free money because it's out there.
Get that free money from your employer, especially because you've earned it.
You have. Yep. It's part of the comp plan.
There you go. All right. Well, thanks for listening.
Yeah. Talk to you soon.
The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, Consult the appropriate qualified professional prior to making a decision. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies. Investing involves risks, including possible loss of principle.
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Description
401ks are the top retirement account out there. Millennials every day make contributions to a plan they barely understand. In this episode of Millennial Money Matters, we delve into the mysterious world of 401k plans. We discuss the three main decisions you make with 401k plans, how target date fund works, 401k rules and many more. If you have many questions about 401k plans, this episode is for you.
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Transcription
Here we are for another episode of Millennial Money Matters with Derek and Kelly. Kelly, how you doing?
I'm doing great. I'm doing great. How was your weekend?
I am still recovering. I was, my wife was on a girl's trip for four days and this is day four and I am glad she's coming back today.
And so you've been alone with two kids for four days?
Yep, they are five and three, two boys, so they have endless energy. We did probably, I think, Six different activities, like going out of the house, going to different houses, going to the science museum, going to birthday parties. T-ball pictures, which was a cluster.
Oh, I was also at T-ball pictures. I saw you also. And that was chaos.
Yeah. There's just bats everywhere. Yes. Kids everywhere.
Small five-year-old swinging bats indoors. Yeah,
what could go wrong?
Yeah, we were there for double duty because we have two kids in baseball. So my husband was... at Baseball Pictures from 10 a.m. until almost noon.
Well, he's a coach, so he's obviously very important.
Yeah, very, very important. Yeah, no, that was an adventure. But yeah, four days with your kids, no matter what. That's a lot of days alone.
You know, I get a lot of credit for single parents out there because I think when you're kind of in that realm of used to doing this, you kind of have a rhythm. We don't have that rhythm yet. So if kids want to stay out late, they're like, Dad, can we do a little fort over the bed? I'm like, I don't know how we're going to possibly do this. You know, they want to sleep in the same bed and they don't. Yeah, it's fun.
Well, and then you also had the surprise rain on Saturday. Saturday was supposed to be beautiful. And then it rained from the moment we woke up until the moment we went to bed.
Kids and rain is always the best combination.
We were supposed to have two baseball games that day. Both got canceled. Both got canceled at the last minute. And we were like, now what?
Yeah, I know.
What are we supposed to do with you? We had plans. They're over now.
I tell you, we bought a bounce house for Christmas a couple years ago. And it's small enough to fit in our basement. It's been the best decision ever. Because with these winters in New England, you're just like, get in the basement. Get some energy.
Go jump in the bounce. Yeah. That's a good call. We have an inflatable water slide. So that's our summer activity, which also 10 out of 10 stars would recommend. Okay.
All right. See, you come for money tips, but here you get parenting tips. Correct.
Because this is Millennial Money Matters and lots of us millennials are dealing with children.
We are. Yeah. So what's our topic today, Kel?
Our topic today is 401ks. And I love this. Part of Derek and I's exploration of doing these podcasts are we have discussions about these topics. And 401ks are... I feel like a bit of a mystery to a lot of us in that our parents are not always the most helpful in educating us on 401ks because they come from the era of pensions.
They do. Yeah.
How's your pension? You're like, nobody's had a pension in 20 years.
Get a job with a pension. Where? Where? Government. That's about it.
But even the government, it's not super common these days.
They're getting worse. I have some clients in the other age of this pension program that work for the state of Connecticut here. And the ones that are about to retire are looking pretty. The younger folks, it's going to be a little dicey.
I see. So 401k is definitely more common. I think that there's a lot of myth around it. And even I, like as Derek and I chatted about this and I had questions and he's like, no, that's not true. No, that's not true. So I'm an educated financial professional and still don't necessarily know a lot about 401k. So tell me a little bit, Derek, like what's, give me some basic facts about a 401k.
First of all, your impression of me was spot on. I just want to point that out. Yeah, that was amazing. Well, you know, I always tell clients there's really three main things you need to worry about with a foreign K in general, and then I'll get to some crazy stats we have. But really when it comes to your decision on a foreign K, you want to think about how much you're saving, what type of tax treatment you're going to save, and what are you going to invest in? Let's not overcomplicate it. That's really the only things we're looking at. But in terms of foreign Ks in general, here's some kind of stats that I looked up. So basically about 56% of the workforce has access to a foreign K plan. So everyone thinks, oh, foreign Ks are ubiquitous or they're everywhere. That's actually not the case. It's kind of the same thing with the whole pension argument. not as many people had pensions as you thought. So a lot of us are actually on our own when it comes to retirement savings in general. So just keep that in mind. There's an average of 28 investment options in a 401k plan. So it's not like we've got a million options, like, no, you can't invest in Bitcoin in a 401k.
Oh, come on.
I want that. Never. Yeah. And then about the number one investment option is a target date fund. So we're going to get a little bit about what those are, why they're fit, about... 43% of plant assets are actually in a target date fund. If you look at Vanguard study, just on Vanguard assets, it's almost 60%. Yeah, so most people just default to that. So it's important to know how they work and what they're on. And we can talk about that a little bit. Do you want to know how much we have saved by generation?
I would love that because again, we're really targeted millennials here. But yeah, what are people saving?
All right. So here's the thing. We got some work to do. Okay. So Gen Z, they're just starting out. So let's give them a break. Their average Our 401k balance is $7,100 and their mean is $2,500.
But they got time.
They got a little bit in there, but they got some ways to go. Us millennials, we've got $44,900 on average and only $15,500 mean.
Which is not good because again, I'm an elder millennial. and I'm 41, which means my time to retirement is not that long.
No. I mean, this is the point where if you're not saving yet, you need to put in a ton more than you would if you just started earlier. So if you're listening to this thing, I'm a little behind, like get going. Gen X, we're at 145,500 average and then 44,000 mean.
So they're doing a little bit better. Yeah. Not enough to live on though. That's not 20 years worth of savings for you in your retirement. Not at all. That's like one year.
Right. And boomers, quite frankly, they're not doing much better. They're at 215 average and then 61,000 mean. So that is not a lot to live on when you're going to retire in three weeks.
They all thought they were getting pensions, so.
They did. And they probably don't have them. So. We'll see. So that's kind of the current state. So clearly we have some work to do. The 401k is one option to help build up your wealth for retirement. So Kelly, do you want to ask a couple of questions? I know you had some questions.
I'm depleting this in that I feel like when we talk retirement, people automatically default to the 401k. Like, yeah, yeah, I got a 401k. And again, good option. But can you get a 401k if your employer doesn't offer it? Like, is that something that everybody should have a 401k or it's really, are you just using it if it's available from your employer?
So a 401k is an employer-driven plan. So it's only available if A, your employer offers it, or B, you're a solo practitioner, solopreneur, whatever you want to call it. You can set up your own. It's called a solo 401k. Those are really the only avenues to actually go get your own 401k plan. So if you're just working for so-and-so X, Y, Z company, and they don't have a plan, you cannot get a 401k. Okay.
Now what is... So I have a 401k. I'm putting money in it. Now... I think the biggest benefit that most of us know is your employer can put money in it as well. What drives that? What drives how much is put into these? How does that work with your employer?
So the employer typically will decide what you're referring to the match. And typically, there's two money types that go in there. I'm going to go into four. There's four money types. There's the money that you put in, that's considered the employee contribution. Then if an employer offers a match, not all of them do. They'll match either like dollar for dollar to X percentage or 50% to X percentage. Usually it's some cap amount. Then there's the profit sharing. So usually if it's a smaller business and the owner has a really good year, incentivizes the folks, say, all right, I'm going to dump some extra money in the plan. They'll do that for you. And then some plans, and this is where every plan is a little unique, so you have to read it and talk to a nerd like me that will actually read these documents and understand them. They offer what's called after tax. So that's above and beyond what you put in as an employee. you can actually put in after-tax money. So if you look at all four of those together, you can put it up to, in 2024, $69,000 a year into a 401k plan.
Oh, so you can't put whatever you want in there?
No, there's limits. So the employee part is $23,000.
Oh, I can only put $23,000. So if I want to save more than $23,000, then I have to have more than a 401k? Correct.
Or you have to be over $50,000, because then you get the catch-up, which is another $7,500 for this year. Or if they have, like I said, the after-tax option, you can get it up to 69 if you're doing that. But not a lot of plans out for the after-tax. It's pretty rare.
Now, what happens, I think for a lot of us, right, our parents'generations often started a job in their 20s and worked there for the rest of their career, right? So 40 years. That is not the same for millennials. We're kind of job hoppers. It's a hallmark of the millennial generation that we have hopped jobs. And you may have a collection of 401ks. So I, for example. if I was to count, most of them have been rolled over at this point, but I have had six different 401k plans, six different employers. Should we be leaving those at our former employer? Should we be rolling them over? Like, what do you do with these things? Because I think a lot of us just, it's living somewhere. It looks like it's making money. So we're like, not going to worry about that. But like, should I be rolling that in? Do I roll it into a new 401k? What do I do with that?
Well, so I'll just break down the, you basically have a few options when it comes to that. So option one is you can leave it in the. former employer's plan. Some of the downsides of that is like, let's say they go out of business or they move plans or the people you don't know don't work there anymore. They can be a lot harder to track. I don't love it leaving them there, but you can do that as an option. The other option is you could roll it into your new company's 401k plan. Almost every 401k plan is going to let you roll money into it. The other option that I hate is you could just take all the money out, but then you're paying taxes and a 10% penalty. So not necessarily the best choice. And then the fourth one is rolling the money into an individual retirement account. So you have Roth dollars, roll into Roth IRA. If you have traditional, roll into traditional IRA. There's some pros and cons to each. Like I mentioned, there's 28 investment options on average in a 401k plan. It's okay, but IRAs literally have endless amounts. So there's thousands of investment options.
Can I invest in Bitcoin?
Not in a 401k plan, but you probably could in an IRA. So it depends. Do you want more control over what you have? um the other kind of random thing that i'll bring up to people and usually no one says anything about it but it's creditor protected in a 401k plan it's not in an ira um and i did have a client where that actually did make some sense because he had a pharmacy and he's like you know in case anything ever happens with that um that's
one thing to look at is 401k assets are creditor protected creditor protected all right so what if i'm looking at 401k options you know i i have a 401k right now i my money comes out it goes into it I didn't really, I had to pick aggressive. slightly aggressive or less aggressive as my investment options. So it wasn't a lot of choices that I was getting. Should you have your, if you have an employer sponsored plan, should you have your financial advisor take a look at that documentation and help you choose even if they're not the one managing that plan?
Well, technically we're actually not really supposed to help them pick the options in the plan because we're not directly managing those. But I think it is worth coordinating the investment options with what you have outside of it in general.
So just have a conversation so everybody's on the same page. Now in the employer portion, now I think a lot of us, right, when we look at the balance of our 401k, like I open it up, I see monies, I'm like, look at all those monies, but they're not all mine.
No, you'll probably see two, three line items depending on how much tax you have. So you have your employee contribution. That's the money you put in. That money is always going to be 100% yours. So if you left three weeks after joining the employer, that money's always going to be yours. The other option is the employer match. And those typically will have a vesting schedule. Some of them don't. I'm not going to get too technical with it. But that's one thing you want to make sure you understand in your plan because some will have a three, four, five, up to a six-year vesting schedule. So it means you have to be at the employer for six years. And some are cliffs where, you know, maybe first two years you get nothing. And then all of a sudden you get 50% of it. And some will get 25% each year. So you just really want to make sure you understand when the employer gives you money, when is that officially yours.
And when can you take money out of a 401k?
While you're in the plan, there's not a ton of options. And this is, once again, going to be plan specific. But the general options you have are taking out as a loan, which we can get into. And then generally, some plans have hardship withdrawals. So there's a death, a disability, death of a family member, something like that, where you need to take some money out penalty free. They'll let you do that. Otherwise, if you just withdraw money, you're paying taxes and a 10% penalty.
Now, what age can you? get the money out of that on a regular basis without all these penalties.
Age 59 and a half is when you can officially get all that with all the penalty issues.
Half seems like a common age in the conversations we've had for retirement, right? 59 and a half is like, that's like the, I'm now a real grownup.
Yeah. I don't know how they pick that specific age considering everything else is 65 or social security even starts at 62. So I'm not sure exactly how they came up with a 59 and a half, but that's generally where, okay, now I can move money out. And a lot of times you could actually move money out while you're still working there. So if you have like my big kind of pet peeve with 401k plans, they generally have very mediocre options when it comes to actually taking income in retirement. Generally, there's like three bond funds and a stable value fund, which is basically a money market, which pays half as much interest as you would get like a high yield savings account. So you can actually take money out and do what's called an in-service distribution and get money to another IRA while you're still working. Because generally, you can't just roll over your 401k while you're still working to an IRA.
So let's talk about loans. A lot of us will see, especially we've covered in other episodes, that a lot of millennials don't have a lot of savings. We don't have a lot of emergency funds. So say I'm a millennial, but I have done well with my 401k. I've got $200,000 in there, but that's kind of my money. That's what I've got. And I want to buy a house, right? Here's your friendly neighborhood mortgage lady. And I want to borrow money from my 401k. Can I do that?
You can. So you can take a loan out for any reason. They're not going to ask you, like, what are you taking this money out for? But with a loan, there's definitely some things you want to watch out for. like once again, the plan documents will dictate like what you can take out, how much, but generally it's about 50% of what you have in there. So if you have 200,000, you can take a loan up for about a hundred thousand. Uh, everyone says, well, great. I'm paying myself interest, but you are taking money out of an account that is earning money hopefully, or is at least invested. Um, so that's, there's an opportunity cost associated with that. Uh, and the one thing I mentioned to you was, um, if you leave your employer, you're going to owe that money back right away. Oh, so if you take out a hundred thousand dollars and you say, yeah. I got my new house. I'm going to get a new job, my whole new life. Guess what? You got to pay that $100,000 back right away.
Now, what happens if you leave that 401k? Can you move the 401k while you have a loan on it?
Nope. No, you need to close out all debts before you can move that 401k.
This is good to know. Yeah. And I do have clients on the mortgage side that will take out 401k loans for things like down payments and stuff like that. And a lot of times they'll try to ask us, the lender, a lot of questions about it. And I always defer right back to you need to speak to the plan administrator. Because every 401k is a little bit different and the rules are a little bit different. And then that vested amount, a lot of times you can't borrow the employer contribution. And if you have an employer that's contributing a lot, a lot of what is in your plan may be an employer contribution and you can't necessarily touch those funds.
Yeah. Before you go the loan route, make sure you go through the plan document. Every plan is going to have a plan administrator. That may be someone in HR. That may be a financial advisor attached to it. That may be. They're called third-party administrators. There's going to be someone you could talk to that can outline the ramifications of the loan. And generally, there's a loan fee. It's not usually much. It's usually a couple hundred dollars. But just know that those are some of the issues you can run into with loans. Although I thought it was interesting what you were telling me about how loans are countered with mortgage with 401Ks. So I'd love to. Yeah.
People are looking for down payment money and they're trying to figure out ways to get down payment money, especially if you're selling, say you own two houses or you own one house, house A, and you're trying to buy house B before you sell house A. And that is a very common scenario right now is I want to buy a new house, but I don't want the seller of my new house to think that it's contingent upon the sale of my old house. So I need to borrow money for my down payment because I'm not necessarily going to close on my sale first. So people will turn to their 401k. So what's great about that on our end from the mortgage end is we don't count for a 401k loan as part of your debt to income, where if you were to take out any other type of loan that's somebody else's money, if you've got a $300 a month payment, that's $300 that's hit on your debt to income. And a lot of people will sometimes take out like home equity lines on their current home to use as a debt payment on their new home. Well, if it's a $300 a month payment, that's $300 that we're going to count. The reason why we don't use... that debt in a 401k loan is you are borrowing money from yourself. It's not another creditor. So if you were to theoretically not pay it back, you are just not paying yourself back. You are not, it's not another person whose money is owed to them.
Yeah. You're not defaulting on. Exactly. You know, they're not going to come after your house or other asset, right?
There's ramifications on the 401k, right? And there's ramifications. You're going to pay taxes. You're going to pay penalties. And honestly, I always tell people it costs a lot of money for to get that money if you don't do it correctly. but we don't count it in your debt to income because it's your own funds.
That's interesting. I never actually never heard of that. I mean, I'm in general just more conservative as a financial advisor. So I don't love the taking money out of loans, especially in that scenario where it's like really time because I know a lot of things can go wrong at closing. Yeah. Last minute, you never heard of like, oh, shoot, now I'm going to get the money back on day, you know, 90 or 98 or whatever. You're like, uh, what do I do about it?
Back into there right now.
Yeah. So that's, you know, I just generally. I generally, my thing is when you're thinking about how much do I put in the 401k, it should be for retirement. Like think this is my retirement money. And if you really need to save it for a house, I would still recommend, okay, let's, let's create an account for that. But I do understand, Hey, there's an opportunity where like, I have this house, I need a little extra money for it. It's going to really help my cashflow moving forward. You know, it can make some sense. I like that more than, Hey, I need to buy a car. I love this. You know, I don't know what you call Lexus or whatever you want to say. Like, I need to get this. I'm going to borrow my money for like, there's better assets to buy things with. The houses are one thing. Buying, taking loans out for things is probably not my favorite option.
Yeah. And I would agree with that too. I think for us on the lending side, it is a little bit of a last resort. Again, can be useful if you are on the younger side. I think it's less of a big deal. I have occasionally had people nearing retirement who are borrowing funds from their 401k. And that definitely gives me, you need that money making money at that point. You do. Yeah. You need that money making money. And as you said, there is a time cost in borrowing that money because you're taking it out of the market. You're taking it out of your investments. And like, what if there's a big upswing in the markets while the money's out, you didn't capitalize on that.
Right. Because the argument I always hear is, well, I'm paying my self-interest and the interest could be, I mean, I don't even know now, and that's probably 8% or 9% right now. So like, oh, cool. I'm earning 8.9%, but you're paying that. So it's not like it's free money. But if the money was in the market and the market goes up 20% that year, you lost 12%. Yeah,
exactly. So it's definitely something to contemplate. Now for these 401ks, you use the word vested and we... Didn't really get into that. What does vested mean? Like what is the definition of that? And why do I care if I'm vested or not other than me leaving my employer?
That's just essentially when the money becomes yours.
So it's not yours until that point.
Right. So the money you put in is always 100% vested. The money your employer puts in most of the time will have a schedule. Sometimes it doesn't, but that's where you need to understand how that works. Because some plans, they'll give you the money right away and it's yours day one.
Okay. So what if I take a loan out? Right. So I'm going to borrow money. I'm not fully vested. I am going to leave my employer. Now you said I owe that money back. Right. If I leave my employer. What are the penalties for this? Because that's the part like that I think people don't get is if you're paying, it's not just the 10 percent penalty. You're also paying taxes.
Yeah. It's going to they're going to basically treat it as you taking the money out.
It's gone. Right. Correct. And you're not going to get it back. Correct. So that could be that could be. big financial hit for people.
Especially depending on your tax bracket. So there's a whole lot of issues you really wanna be aware of, okay, like if X, Y, Z happens, you know, what do I do? So it's good, you know, go for the loan, that's fine. Just make sure, okay, if it hits the fan, what am I doing?
Now, employer contribution-wise, should you be maybe checking? that what that is before you accept jobs like is that something that should be a part of your contemplation if you're looking at job a and job b and one match is six percent and one i'm going to use nine which derek will laugh about i i work at used to work at an employer that matched nine percent um and it was like unheard of i know i'm gonna faint over here it's crazy nine percent it was nine percent and my fun fact is i did not contribute to that 401k for the first three years that i worked for this and you didn't have to put nine percent in to get the nine right put six six Cool. Yeah. It was a big money waster. It was a big money waster. But again, I think especially, and this is probably those Gen Zers, is when you're in your early 20s, first off, retirement seems a thousand years away, right? So for me, when I was in my 20s, I think they were taking like $50 out of my paycheck. But at that time, I was like 24, $50 in my pocket felt like so much more than $50 in my retirement. And if I had ever understood what that money meant to me today, I would have happily given them my $50. But I mean,
that meant $75 was going in for you on top of that.
On top of that. Yeah. And I just didn't understand that. And what's that money now 20 years later? Like lots of money.
Yeah. I think it's important to put a little perspective too, because a lot of people think a lot of, unfortunately, when you read the documents, it's always percentages. So it's like, oh, it's 6% of the salary, 3%. But if you're like, all right, let's be real here. If you make $50,000, 3% is $1,500 a year.
Which is not a lot.
It's not. Crazy. It's a little over a hundred dollars a month. So it's not like, oh my God, for sure, almost all of us can find a hundred dollars a month somewhere, even 50. Right. So the fact that they're going to double that money for you, now you have $300 going to your account every single month.
Yeah. What could you be doing with that in 20 years?
Right. And so it's, it's, um, you know, basically I think the stat is if you started at 25, you need like $581 or something along those lines to get a million by the time you're 65.
Well, and a million, I think we talked about this on an earlier episode, like. A million sounds like a lot. That's the minimum that most people need in retirement. Like a million will get you like continuing to live the lifestyle you've been living while you're employed and some of your health care costs covered. But you're not on a yacht at a million dollars in retirement like living the high life. Your life is OK. You're paying your bills. But you have to live on that, especially because people are living longer and longer with more health care costs. If you're retiring at 65 and you live to be 95.
Good luck.
A million dollars for that length of time does not go very far. No.
Well, you know, one point I want to make about the match, because I think it's the biggest missed opportunity I see, because folks that aren't taking advantage of it, it just drives me nuts, because you're automatically getting a 100% rate of return in most cases. You got a 150% rate of return. Yeah,
but it didn't do it.
On average, the stock market earns 10. So you're doing 10 times what the stock market does with no risk, because the employer is just throwing money at you. So now you're compounding that plus a 10% on top of that. It's such a missed opportunity. And it's like if I gave you $100 or you gave me $100 and I said, all right, here's $200 back. You do that all day.
All day long. I'd be like, sure, here you go.
Yeah, why not? The only difference is it goes into a different account that you can't touch for a little while, which I get is probably annoying. But it's such an opportunity to make an extra wealth.
Now, what if your employer doesn't match? Is it still worth it to have a 401k?
Generally, it is because it depends on your situation. But especially for higher income earners, it's... and your W-2, it's going to be one of the only tax vehicles you have. Because when you make too much money, you get phased out of a Roth. When you make too much money, you're going to have a tax problem, right? So the pre-tax piece of it's going to be really important for you. And if you're doing both, you can actually do a backdoor Roth with a pre-tax. So you can really probably get a little weeds here, but basically you can-Backdoor Roth. I don't know who names these things. Yeah. But basically you can leverage that as a tool. And a lot of people are like, oh, it's a scam. You see the stuff online now. It's like, don't do this. Do this instead. Invest in real estate. It's like, okay, let's take a break here. If you're not getting a match, it's still a good vehicle to use because you are getting that tax treatment. Just be frank. W-2 people do not have tax deductions. Good luck.
Yeah,
no. You don't open an LLC for a W-2 person. You can't just do all this stuff you hear on TikTok, right? So you do need that option to say, okay, I'm going to put some money in here. It's going to be my retirement account. This should not be, across the board, the only thing you save for retirement. because you are locking your money up. But it's a good tool to just kind of save automatically. I mean, for most of us, we're just terrible at saving in general. So having something that automatically comes out of our paycheck is really important too.
Yeah, right. Well, and that's it, right? It's the set it or forget it. It goes out. You don't even think about it. You're not moving it. That's what I like about the 401k is that it's like what I don't see, I don't know. It just comes out of my pay. Mine is a percentage that I put in. So it's base and I'm commission-based. So my... paychecks look very different every month, but it's a percentage. So some months it's a lot, some months it's not, but months that I get paid a lot, it's a lot of money. Cool. It's gone. I didn't even know that I got it. Right.
And you know, the other beauty of it too, is the market's going to fluctuate. So it's going to be up and down. So the nice thing is because you're putting money in every paycheck, which is every week, bi-weekly, whatever, you're going to write out, you know, you're going to kind of, I don't know. The gains aren't going to be as bad and the loss aren't going to be as bad either because you're buying things at a discount. You're buying things, you're buying less when the market's up. So it's going to even out your returns over time because you're being more consistent with it. Instead of being like, oh, yeah, I have an extra $50 after saving for three months. I'm going to dump a bunch of money in all at once and try and time the market that way. This is just boom, consistent, every single paycheck, money's going in the market and the market goes up. Great. If it goes down, even better because now I get things at a discount.
Yeah. And I'm one of those people where I'm not allowed to look at my 401k. because I get very wrapped up and like it went down and my husband's like, stop looking at it.
I wish I can get everyone to realize that. The best actual course of action for the market just suck until you're like five years before you retire and have a shoot up. That would be ideal because now you're buying things as cheap. Like you actually don't really want your, if you're younger, you don't want your balance to go up as much. You just want to put more money in it all the time because you're buying things at a discount.
Yeah. So it's getting a little better. So any last minute thoughts for people on a 401k, any tips, tricks, things they should know?
Actually one, one big thing I think we kind of didn't talk about it, which I mentioned earlier is a target date funds, right? Cause that's, that's the number one investment that most people have. And most people aren't really familiar with how they work. And I'll just give a quick primer on that because basically it's going to take your age when you think you're going to retire and it's going to be aggressive now. So more stocks over bonds. And as you get closer to retirement, it's going to be a little bit more conservative. One thing to watch out for, there are two types. And this is going to be a little technical here, but it's basically there's a through glide path and a to glide path.
That sounds a little Spanish.
You're like, what is happening?
What does that even mean? Derek right now.
And I'm going to explain it. So basically. A lot of people are like, oh, my target date sucks. I lost all this money in 2008. It's because they had a through glide path. They assume you're going to retire at 65, but your retirement's going to last 20 plus years. So we're going to stay aggressive. So people thought they were really conservative when they retire,
actually weren't.
And the two one says, okay, you're going to retire at 65. We're going to be conservative at retirement. So I think it's very important to understand which one you're in.
And now do you choose that when you set up your 401k?
So your employer chooses the, and each targeted company does it differently. Like Vanguard will do it differently than American funds or Fidelity. So you just really want to look at, you know, the easiest way to do it is kind of look at like a targeted, like 2020 or 2019 or 2015 fund to see where they are from an allocation standpoint. And it'll tell you if it's two or three. But it's a small thing that people probably don't think about, but if you're at 60 years old and you've got five years of retirement, like, do you really want to be that aggressive? Maybe you do. I don't know, but.
you know just something to watch out for because that's something that people don't realize they think they're conservative they're not oh i would have no idea so it's often very overlooked like i know it's a little nerdy but it's uh it's important to understand how that works and how you're saving well this is why having like a great financial advisor as a partner i think is so important because again even if they can't advise you on your particular plan someone to ask questions of so you understand what options you have and you understand like what am I signing myself up for? What do these words mean? Because I've never heard that before. And again, educated financial professional here, that was a whole different language to me. So I appreciate that.
Yeah. We have our own language over here. Yeah.
That's true. Well, listen, so do mortgage people. So it's part of the deal. And that's what we're here for, to educate people about all this stuff that nobody tells you about.
Yeah. So I mean, that's all I really have to talk about with the 401k plans. I think they're once again, the great tool, not the only thing I would ever invest in. But definitely a useful thing from a tax standpoint, from a savings standpoint. And get that free money because it's out there.
Get that free money from your employer, especially because you've earned it.
You have. Yep. It's part of the comp plan.
There you go. All right. Well, thanks for listening.
Yeah. Talk to you soon.
The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, Consult the appropriate qualified professional prior to making a decision. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies. Investing involves risks, including possible loss of principle.
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